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Most Read: Soho China Ltd, SK Telecom, F&F, Afterpay Touch and more

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In today’s briefing:

  • Last Week in Event SPACE: SOHO China, Invesco Office, Iress, WH Group, PCCW
  • Global Capital Spending: Recovering After Resilience During Pandemic, but Nuances Persist
  • Did Passive Rebalancing Trading on SKT Start Last Friday?
  • KOSPI200 Index Rebalance Preview: Two Changes in September; Five in December
  • Afterpay (APT AU) – Square Is Buying Now in an All Stock Deal

Last Week in Event SPACE: SOHO China, Invesco Office, Iress, WH Group, PCCW

By David Blennerhassett

Last Week in Event SPACE …

  •  SOHO China Ltd (410 HK)‘s shares were utterly cremated, ostensibly in response to a media report the pre-conditional Offer from the Blackstone Group faces regulatory obstacles. Yet that media article was vague in context, and ultimately stopped short of saying the deal would be blocked. 
  • The Invesco Office J Reit (3298 JP) deal is done. The bidders have 65.07%. This is close enough to win an EGM to consolidate. The bidders could buy more shares on market to get to just under two-thirds, or perhaps even go much higher. There will be index sells first though.
  • The bidding for Australia’s tech companies continues as Iress Ltd (IRE AU) receives an indicative proposal from EQT Fund Management.
  • The Seven Group Holdings (SVW AU) Offer for Boral Ltd (BLD AU) closed late this past week with Seven gaining 69.6%. This prompted some movement on the Board and the close of the Offer will lead to index changes.  
  • The MBO for Sakai Ovex (3408 JP) launched in February and failed in March has now been re-launched, with the activist who effectively blocked the old deal at ¥3000/share now participating in the buyout at ¥3810. It was far from fair the first time around and it is far from fair this time (the activist isn’t selling).
  • WH Group (288 HK)‘s Offer Doc is out. There are things to do here for hedge funds and arbitrageurs. There are things to do here for long-only funds who love the stock. 
  • PCCW Ltd (8 HK) further slims down after entering into a SPA with DigitalBridge Group (DBRG US) to sell its Hong Kong and Malaysian data center businesses for US$750mn. 
  • The Allcargo Logistics (AGLL IN) Delisting Proposal is now “re-initiated” after a SEBI Delistings Regulation change which went into effect last month, not grandfathering in the promoters’ pre-existing Delisting Proposal process. The stock has rallied hard on that news.
  • Plus, other events, CCASS movements, and Mood Spins.

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classifications, and Events – or SPACE – in the past week)

M&A – ASIA

Soho China Ltd (410 HK) (Mkt Cap: $2.0bn; Liquidity: $7mn)

Following a media article, shares were down 31% at one stage, or 48% adrift of the $5.00/share offer price, and 13% below the undisturbed price, before recovering to close at $3.02/share. The article mentions the SOHO China/Blackstone deal has the attention of the Chinese government and is unlikely to face a smooth regulatory approval process in China. In addition, “the deal is expected to face obstacles in obtaining approval, but the issues relate more to the founders, than the deal itself.” The source of the article is understood to be “familiar with the situation”, not working on the deal. For context, I’m familiar with the situation.

  • Apparently, according to the article, Zhang Xin and Pan Shiyi are in the US. We don’t know for how long, or whether this is a recent development. Moreover, there is a question as to whether they need to be in China to be “interviewed” for the deal to complete. One interpretation of this article is the founders need to offer up “something” to get this deal over the line.
  • The current environment is unquestionably one of general risk aversion given all that has happened with Chinese regulators and internet names. SOHO China is a crowded trade and short-term investors are being stopped out, further exacerbating a difficult situation. And being month-end, this is awful timing for many players.
  • Short interest is my biggest concern on the deal. Aggregate short interest on the 9th July was 98.5m shares, with Bloomberg, implying at the time, an additional ~35m short sold since then, or an increase of 35% in the last 2 weeks.  Short sell volume, as a % of total volume, appeared to be ~20-40%. You don’t short something which could be 30% (before yesterday’s move) in your face instantly unless you are certain. Or know something. 
  • This is adding up to one of those “circumstantial evidence” issues. The whole lot could be a circular reference – rumour begets rumour etc. But on balance, this deal should get up. There was clear adding/buying on the big fall day on the pretext this article was weak. The downside to a deal break is now less hairy. If this deal was blocked, for whatever reason, the downside is unlikely to be the undisturbed price, but probably closer to $2.30-ish or 24% down, compared to 66% up to the Offer price. That suggests a 2.75 upside:downside ratio, though where “downside” is can be tricky.

(link to my insight: SOHO China (410 HK): In For a Penny …. )

Invesco Office J Reit (3298 JP) (Mkt Cap: $1.8bn; Liquidity: $24mn)

The bid by the Invesco parent company (Invesco Real Estate and affiliates) for Invesco Office turned out successful, and the bidders gained 5,727,676 units out of the 8,802,650 units out in the float. They now own 65.07% (having started with 6%) so this will end up going to an EGM. Travis Lundy expect cash-out will be received sometime between early December 2021 and late January 2022 but there are weird things which happen. There could be a short squeeze. 

  • There will be index deletions of MSCI, FTSE, and S&P DJI Global in the next several trading days. That should mean a sale of say $180-250mm of stock, though some of it will already be sold in the tender. Some announcements may show up tonight.  There will be a TSEREIT Index deletion which could be US$350-500mm which will happen at the close of the third business day after the EGM decides to consolidate units and delist. 
  • When the deletions happen, there will be buying of the other names in their respective indices.  For the international indices, it is diverse, and non-impactful. For the TSEREIT Index, it should be $350-500mm to buy at the close, which is about 0.7-1.0x ADV of the collective constituents. 
  • Now that this is done, Travis expects the “right” trade is to buy the shares at a decent spread expecting to be able to get one’s JPY 22,750/unit by end of year or early January.  I would want to see a wider spread than where we closed, because there are lots of very wide spreads right now in Asia and risk capital can be better allocated elsewhere.
  • UPDATE:  the TSE announced a hybrid treatment whereby the weight in the TSE REIT Index would be lowered as the FFW dropped from 1.0 to 0.35, effective 31 August 2021. This means a likely index tracking sell of 1.1-1.4mm units at the close of 30 August 2021. The FTSE released their treatment of the downweight which is for unchanged shares in issue total of 8,802,650 and a decreased investability weighting from 97.52559% to 32.4579569576774%. That is a float reduction of 5.73mm shares. That selldown will take place 2 August at the close.

(link to Ttavis insight: Invesco Real Estate Deal for Invesco Office (3298) Successful – Now For the Aftermath)

Iress Ltd (IRE AU) (Mkt Cap: $2.0bn; Liquidity: $6mn)

Trading and wealth management software provider Iress announced it had received a confidential, unsolicited, non-binding, and indicative proposal from Swedish PE outfit EQT Fund Management via a Scheme of Arrangement at a price range of between A$15.30 and A$15.50 cash per share. EQT had previously fielded an Offer of A$14.80/share on the 18 June. Iress’ board unanimously concluded that the Proposal was “conditional and did not represent compelling value for Iress shareholders”. But the board was “prepared to provide it with access to limited non-public information so EQT can develop a proposal that is capable of being recommended to shareholders.”

  • After announcing on the 10 June it had not received any direct approaches, the following day Iress (unprompted it appeared at the time) announced a strategic review, including the divestment of its British mortgage and sales origination business, or MSO; accelerating earnings through M&A, and taking on more debt to buy back shares.  The forward target. In a more detailed strategic review announced today, Iress forecasts an NPAT of ~A$120mn by FY25, up from A$59.1mn in FY20, via “building scale in large addressable market with a focus on the UK, superannuation and investment infrastructure”. 
  • The offer is pitched at a forward EV/EBITDA of 22.4x. This compares to Iress’ five-year forward EV/EBITDA average of 17x. The five-year opener average is 11x, and Iress has traded at a 54% premium to peers over the past five years. 
  • Although the board concluded EQT’s offer did not represent compelling value, it remains engaged with EQT and has provided limited DD.  What price? Roger Sharp took over as Chairman in February and he is known to be a canny dealmaker and wants to leave behind a legacy, and he and the board have a clear intention to building out the business. But a A$17/share bid – 10% above the high-end of EQT’s range – probably garners board support. Even 5% – ~A$16.30 – may get the job done. As it is, EQT’s proposal is already at a life-time high. 

(link to my insight: Iress (ASX AU) Bats Away EQT – For Now)

WH Group (288 HK) (Mkt Cap: $11.8bn; Liquidity: $34mn)

On 6 June 2021, WH Group (288 HK) announced a proposal for a Voluntary Buyback Offer. The company decided it had enough cash and excess capital given its investment requirements and decided to return the excess to shareholders by buying up to 13% of shares outstanding. Then peers fell. DRAMATICALLY. The 7 names in a HK- or China-listed basket of peers have fallen 23% as live hog prices have fallen and the hog/feed ratio has also fallen, indicating hog producers are making even less than before (or, according to the NDRC, losing more than before).

  • WH Group has now released its Offer Document whereby it launches the Conditional Voluntary Cash Offer for 13% of its own shares at HK$7.80/share.  This will need to be approved by Shareholders – both the Offer and the Whitewash Waiver.  The Record Date for the EGM is 19 August 2021, the EGM is 16 August, and if approved, the Offer will become Unconditional on 16 August and will close on 30 August. Cheques will be sent no later than 8 Sep. Shares not bought back will be returned no later than 9 Sep.  The minimum pro-ration is 19.7%. This remains an interesting situation. 
  • Travis is bullish, but too strong a jump post the Offer doc would be a good reason to unwind unless you are VERY bullish the back end vs Peers. 10% higher and the stock is still reasonable to peers on an accretion-adjusted basis, but Peers have fallen a LONG way and they are volatile.  If you are short Peers against WH and hog prices start to go up, then watch out! The Peers came down faster, they can go up faster.  Long-Only investors who like WH Group at the current level should buy 25-30% “extra” of their position using cash and own 125-130% of their position size. At yesterday’s close, that extra 25% position will earn 26%.
  • At the then current price (HK$6.21) Travis liked it outright long and against a Global Basket of Peers. He would shrink the size of the hedge against HK/CH-listed Peers. He would track the Implied Participation Rate levels.  If you are LONG ONLY and you like the stock, there is a great trade to do here. If you are a delta-neutral ARB with no borrow, there is another 5-8% in outperformance before this starts becoming substantially less interesting. If you are a delta-neutral ARB who has oodles of GTNA borrow, you should already be in this with both feet, and you should not get out until the stock goes up a lot.

(link to Travis’ insight: WH Group Offer Doc Out – This Little Piggy Went To Market)

Spark Infrastructure (SKI AU)  (Mkt Cap: $3.5bn; Liquidity: $7mn)

After rejecting two take-private proposals from PR outfit firm KKR and Ontario Teachers’ Pension Plan Board (OTPPB), Aussie poles and wires company Spark has ostensibly supported the Consortium’s improved tilt of $2.95/share. The Consortium (KKR/OTPPB)’s latest proposal, up from the initial Offer of $2.70/share, was considered by Spark’s board to be in the interest of its shareholders to engage further. As such, Spark has provided the Consortium with due diligence on a non-exclusive basis. This Offer remains pre-conditional, and is subject to satisfactory DD, together with board approval from both KKR and OTPPB. A firm Offer, should one unfold, would be subject to FIRB approval, and the approval from Spark’s shareholders at a Scheme Meeting. Yet this looks like a full (er) Offer than the one rejected on the 15 July.

  • The assets held by Spark are regulated. You could go further and say Spark simply collects dividends from its minority stakes. Electricity assets are designated critical assets by the FIRB-affiliate Critical Infrastructure Center. But these minority holdings should help facilitate the FIRB application. The trickier aspect of the application is that 100% of SA Power/Victoria Power Networks would be controlled by foreign investors if this deal get up.
  •  The Offer is pitched at ~1.6x regulatory asset base. The RAB multiple for the failed APA Group (APA AU) tilt from CK Infrastructure Holdings (1038 HK) was also estimated at 1.6x. DUET Group (DUE AU) was taken out by CKI in 2017 at ~1.4x.
  • An interloper is possible. . APA remains close with CKI, despite the failed bid in 2018. Plus, this would keep the minority interest stakes in Australian hands.  But again, given Spark’s minority stakes, any successful suitor will not have unfettered control over these utilities.

Sakai Ovex (3408 JP)  (Mkt Cap: $0.2bn; Liquidity: $1mn)

In early February 2021, the CEO of Sakai Ovex (3408 JP), who owned very few shares, and an activist investor decided to launch an MBO for the company at ¥2,850/share.  The stock had been trading cheap, and the price was “high” but the price was wrong. It needed to be 40% higher – at a minimum – in my opinion. Not long after that, the bidders offered a very weak bump to ¥3,000/share, discussed in Savai Ovex MBO – A Very Weak Bump. This was not enough. The shares traded above terms and revised terms, only falling below when the Tender Offer went ex-. 

  • The Bidders are back. And now City Index Eleventh is joining them. It pays to be the fulcrum investor.  And now they are bidding ¥3,810. Which is still cheap.  The president, who holds almost no shares, and a value/activist investor have proposed to take the company private at a discount to book, with considerable non-operating assets and earnings.  There is a lot of value hidden in the details.  This deal was short by probably ¥1,200/share the first time which would have taken it to ¥4,000/share. I personally think it is still short. Perhaps another ¥800-1000/share would be better. 
  • The insiders have about 50% of the shares locked up with Murakami-san. They need about a third of the rest.  This will be incrementally tougher to block, but those who do more digging and decide they too would like to become an equity partner in the takeout, there is actually a possible role for you.
  • Travis would buy at or just below tender offer price. He thinks this gets done. If someone shows up BIGLY there could still be a small bump.

(link to Travis’ insight: Sakai Ovex MBO Reloaded – Up 27% from Last Weak Bump But Still Cheap)

After wood flooring manufacturer Nature Home Holding Company (2083 HK) was suspended on the 19 July, in Nature Home (2083 HK): Possible Takeover Target I concluded if an Offer was to be tabled, it would likely be via a Scheme and at ~HK$1.70/share. And this is exactly what transpired. Nature Home announced an Offer from its founding shareholders, by way of a Scheme, at HK$1.70/share. The Offer Price will not be increased. Dehua Tb New Decoration A (002043 CH) has given an irrevocable rollover undertaking for its 19.6% stake. Standard Scheme conditions apply. On account of the Rollover Agreement, Dehua does not form part of the independent shareholders who will vote on the merits of the Scheme. This Offer looks done. Link to my insight: Nature Home (2083 HK)’s Full Offer.

Advantest Corp (6857 JP) had a good Q1 and revised up its full year. The company also announced a buyback of up to 10mm shares and up to ¥70bn through March next year. Given the current share price, that would only get ~7 million shares bought back but while that is only 3.5% of shares out ex-Treasury, it is 10+% of Real World Float. In Breaking Down Advantest’s Big Buyback, Travis expects that this buyback will contribute to positive/better/high-quality momentum (price and outperformance) on a stock which already has decent momentum both on stock price and fundamentals. 

On the 30 April, aged-care Australian listed operator Japara Healthcare (JHC AU) announced it had received an unsolicited, indicative, conditional, and non-binding Offer from Little Company of Mary Health Care – otherwise known as Calvary – by way of a Scheme, at A$1.04/share. On the 5 June, Calvary increased the indicative Offer price to A$1.20/share.  On the 15 June, the Bolton Clarke Group made a conditional, non-binding indicative proposal by way of a Scheme, at A$1.22/share. JHC has now announced that it has entered into a Scheme Implementation Deed (SID) with Calvary, by way of a Scheme at A$1.40/share. The consideration will be reduced by any dividends paid.  JHC’s board of directors have unanimously recommended the Scheme, in the absence of a superior proposal and subject to an independent expert concluding the Scheme is fair & reasonable. This looks done. Link to my insight: Japara Healthcare (JHC): Calvary Takes Charge.

India-based integrated logistics company Allcargo Logistics (AGLL IN) received a “Delisting Proposal” from its Promoter Group (Shashi Kiran Shetty and Talentos Entertainment Private Limited) in August 2020. Since then, the stock has gained more than 70%. Despite the rally since the Initial Delisting Proposal, Allcargo is not too expensive strictly from a fundamental angle. Going by LTM numbers, Allcargo is trading at a EV/EBITDA of 9.5x which looks cheap when considering that EBITDA CAGR for FY21A-FY23E is ~26% according to Capital IQ consensus.  In Allcargo (AGLL IN): Process Reinitiated! 70%+ Up Now. Should You Still Chase?. Read more: https://skr.ma/xDxmq, Janaghan Jeyakumar expects the Deal to complete. He would be cautious about chasing. However, he would expect dips are good to be bought.  

On the 18 May, Yue Xiu (the investment arm of the Guangzhou municipal government) made an Offer, by way of a Scheme, for Chong Hing Bank (1111 HK) shares not owned, at HK$20.80/share, a 51.2% premium to last close, and a 97% premium to the day preceding the last trading day. The Cancellation Price, which was a 10.1% discount to the NAV, would NOT be increased. Standard Scheme conditions apply. Chong Hing is Hong Kong incorporated, therefore there is no headcount test. The Scheme Document is now out.  The Scheme Meeting will be held on the 30 August with expected payment (assuming the Scheme resolutions are approved by independent shareholders) on the 7 October. The IFA considers the Offer to be fair and reasonable, although that report covered the bare minimum. Link to my insight: Chong Hing Bank (1111 HK): Scheme Doc Out. IFA Says Fair.

STUBS

PCCW Ltd (8 HK) / HKT Ltd (6823 HK) 

At the time of my insight, I had the discount to NAV at ~23%, compared to the 12-month average of 17%. The implied stub of (HK$1.20/share) compares to the (HK$1.05/share) average since PCCW reduced its take in HKT back in February 2017.  The simple ratio (PCCW/HKT) of 0.4x compares to the 0.42x average since the February 2017 reduction. 

  • PCCW Solutions operates 9 data center locations in Hong Kong, China, and Malaysia. The portfolio comprises ~75+ megawatts of power capacity, across 1.3mn sqft of GFA.  This portfolio of data centers made a net profit of US$2.6mn in FY20, up from US$0.02mn in FY19. Net assets are ~US$258.3mn, therefore DigitalBridge is paying  288x trailing earnings, and 2.9x book. PCCW appears to have paid 1.9x P/B for the Malaysian ops last year.
  • I think one of two events will ultimately transpire from hereon – either HKT is taken over – not by PCCW – but by a PRC telecommunication company such as China United Network A (600050 CH), which already holds 18.5% – HK media assets have gradually been snapped up by PRC buyers; or Richard Li attempts another privatisation of PCCW.
  • That’s not to say Richard wants to continue in his dad’s footsteps by holding or acquiring telco assets. I think he wants the cash from the sale of PCCW’s stake in HKT. Following the sale of the data centers, PCCW would be net cash, or thereabouts, at the parent level. Richard has been in the news lately concerning Southeast Asian online realty company PropertyGuru agreeing to go public through a merger with a blank-check firm backed by Richard and Peter Thiel. But Richard’s passion in recent years appears to evolve around insurance, especially the soon (expected)-to-be listed FWD.
  • I would be inclined to be invested where Richard is – and therefore be Long PCCW, short HKT here. I expect the NAV discount to narrow towards its one-year average. 

(link to my insight: StubWorld: The Trimming Of PCCW

Zhen Zhou, Toh is not particularly excited about Del Monte Philippines (1575316D PM)’s business because revenue growth will likely taper off as COVID-19 situation eases and further margin expansion too seems unlikely. In Del Monte Pacific HoldCo Trade Update – A Better Play for Del Monte PH IPO, he thinks that the better way to trade the IPO is to buy DMPL with the expectation that the IPO will go through. And even though liquidity isn’t great, which could mean that Del Monte Pacific (DELM SP) will trade at a deeper holdco discount, there is still potential upside to be realized at those levels.

EVENTS

JAPAN PASSIVE: Who Owns What 2021?

Passive holdings in Japan are approximately equal to 30-34% of the “float” as calculated by index providers such as MSCI, FTSE, and the TSE float calculations (which are generally smaller than MSCI and FTSE) PLUS 28-31,000 baskets worth of Nikkei 225 holdings. Longer-term, this fluctuates in the range of 26-30 million shares. This really matters with names with low share count. But among TOPIX 1000 names which are members, it is a weighted average of just over 4%.

  • That puts Fanuc Corp (6954 JP) and Tokyo Electron Ltd (8035 JP) in the 38-45% range of float, if not a little higher. TDK Corp (6762 JP)Cyberagent Inc (4751 JP)Nissan Chemical Industries (4021 JP), and Kikkoman Corp (2801 JP) are in the 42-50+% range. Konami Holdings Corp (9766 JP) and Hitachi Construction Machinery (6305 JP) are close to or above 50%. Fast Retailing Co Ltd (9983 JP) is likely well above 70%.
  • Last year Travis said “The BOJ may change its ETF allocations.” It did. It stopped buying Nikkei 225 and JPX Nikkei 400 ETFs.
  • As the world moves more and more to passive, expect float to decrease. As companies continue buying back stock, pay attention as to whether it is being repurchased from the market or from designated non-float sellers.
  • Changes to the TSE Market Structure may introduce significant changes to index constituency impact on smallcap shares within the TSE First Section. It will likely not mean much at all for large cap shares.  Many companies are looking at optimising their shareholding structure to make it possible for them to be TSE Prime members.
  • In many cases, there are efforts to reduce cross-holdings because of increased emphasis on that factor exercised by the revised Corporate Governance Code and by new voting policies implemented this year by Glass Lewis and ISS which will recommend votes against directors where more than 10% or 20% of equity value is locked up in cross-holdings. 

(link to Travis’ insight: JAPAN PASSIVE: Who Owns What 2021?)

In China’s New After-School Tutoring Policy Is Out – The End of the Line For Many?, Travis reckons the operating businesses for after-school edcuati0n stocks are likely to be worth almost nothing. The only way they survive as economic entities is to pivot to other training, or to pivot to supporting the national cause. Spin off the teachers and the organizational structure of what they do into an Opinion-compliant construct. Provide it with a little seed capital. Then keep whatever online tech one has and make the tech a fee-earning business.  If it were him, in their shoes, he would be making plans to pivot today.  If any of these tycoons end up with any remaining wealth, that is good for them. He thinks the stocks are a really, really tough thing to own other than for break-up value. Osbert Tang also discussed this situation in China Private Education: How to Position After the Regulatory Crackdown? 

Full Circulation Of H-Shares: July 2021 Update was latest update in a series dating back to Legend’s Conversion of Domestic Shares in June 2018.

  • To date, 28 companies have sought approval to convert their domestic shares and/or unlisted foreign shares into H shares, which would then be eligible to be listed and traded on Hong Kong’s stock exchange.
  • 16 companies have now been given CSRC and Hong Kong listing approval to convert such shares. Five of those have seen various degrees of movement in the converted shares.
  • Sichuan Languang Justbon Service Group (2606 HK) received approval late last year but did not convert – and was subsequently subject to an Offer.
  • To date, two companies have withdrawn their application to convert their domestic shares.  Both of these companies –  Beijing Capital Land Ltd H (2868 HK) and Zhejiang Cangnan Instrument (1743 HK) have now been subject to Offers.

TOPIX INCLUSIONS!

In TOPIX Inclusion Trade Summary: July 2021, Janaghan took a look at the monthly performance of the trading opportunities surrounding TOPIX Index Rebalance events. During the month, we witnessed the Inclusion Events of cloud-based business accounting software company Money Forward (3994 JP), water treatment technology company Nomura Micro Science (6254 JP), and printed circuit board manufacturer Meiko Electronics (6787 JP).  Furthermore, as discussed by Travis in July TOPIX FFW Rebalancing Trade (see above), there were quarterly float adjustments for some constituents of the TOPIX Index which opened up a few trading opportunities. 

M&A – EUROPE

Naturgy Energy Group SA (NTGY SM) is awaiting the decision to be made by the Government on the partial takeover launched by the Australian fund IFM for 22.7% of the capital. The success of IFM’s partial takeover attempt is becoming increasingly difficult due to a delay in the approval of the takeover by the Spanish Government; and Criteria Caixa’s intentions to strengthen its shareholding in Naturgy. Criteria Caixa already holds 25.997%. Assuming it will still purchase up to 29.9%, that is a 3.903% stake pending, some 37.84 mn shares, i.e. approximately €826 mn (at the closing price of 29 July) almost worth the volume of 50 trading sessions (at the last three months average daily volume). Link to Jesus Rodriguez Aguilar‘s insight: IFM/Naturgy: New Developments.
Unicaja Banco SA (UNI SM) and Liberbank SA (LBK SM) will soon finalize their merger after receiving all the authorisations. On 19 July, the Spanish Government gave the green-light to the integration, which is expected to close on 30 July. Liberbank’s shares are trading at a 0.8% discount (adjusted for the merger ratio). Although liquidity is thin, in Unicaja/Liberbank: Final Stretch Jesus recommends a short UNI SM/long LBK SM. The effective merger is highly likely to happen on 30 July.
On 21 July, Bloomberg reported that Canadian Brookfield Asset Management-Cl A (BAM/A CN) was working with advisers as it considers a potential bid for alstria office reit-ag (AOX GR). In Brookfield/Alstria Office REIT: Potential Takeover, Jesus reckons a takeout price could come in at €18.68, a 10% premium over the last reported EPRA NTA and 6.4% premium to the closing price on 23 July. 

M&A – US

In SpinTalk: More Value To Be Had In Now Imminent XPO Logistics Break-Up, Robert Sassoon revisited the proposed break-up of Xpo Logistics (XPO US). This corporate event is now just a few days away and will be executed via  the tax-free spin-off of the logistics business GXO Logistics (GXO US) on August 2, 2021, effected through a 1-for-1 distribution of new GXO shares to XPO shareholders

PAIRS

Roland Corp (7944 JP) Has been shifting production away from China and Japan to concentrate most of the production activities to the Malaysian plant established in 2014 as a part of the business turnaround process that followed a vicious downward spiral in the post-global financial crisis environment. While demand for musical instruments soars across the world, COVID-19 lockdowns in Malaysia continues to affect Roland’s production capabilities. In Short Roland/Long Yamaha as Roland May Fail to Meet Demand Due to Production Shortages, Oshadhi Kumarasiri believes Roland may fail to meet demand amidst disruptions to the main production facility in Malaysia while Yamaha Corp (7951 JP) seems to be well placed to outperform the market through capturing Roland’s lost demand.

INDEX REBALS

With Gulf Energy Development Public Company (GULF TB)‘s Offer for Intouch Holdings (INTUCH TB) closing next week, in GULF/INTUCH: Nearing The End of the Offer Period; Passive Selling to Come, Brian Freitas expects FTSE and MSCI to lower Intouch’s investability weight/ FIF over the next week due to a drop in the free float and this will necessitate passive selling on the stock.

In Kakao Bank: Allocations, Lock Ups and Index Fast Entry, Brian sees KakaoBank (1349010D KS) as a high probability inclusion in the Korea Stock Exchange Kospi 200 Index (KOSPI2 INDEX) with the implementation at the close of trading on 9 September.

At the IPO price, Krafton Inc (259960 KS) should get MSCI Fast Entry if less than 30% of the institutional allocation is locked up, while the stock should get FTSE Fast Entry even with 50% of the institutional allocation locked up. If a higher percentage of shares is locked up, the stock will need to close higher on listing day to get index Fast Entry. Link to Brian’s insight: Krafton IPO: Bookbuilding Results & Index Fast Entry.

STAR50 Index Rebalance Preview. With only 2 trading days left in the review period, Brian sees Shanghai Shen Lian Biomedical (688098 CH)Piesat Information Technology (688066 CH)Guangzhou Fang Bang Electr-A (688020 CH)Shenzhen Lifotronic Techno-A (688389 CH), and Appotronics Corp Ltd (688007 CH) as high probability deletions from the index. Link to Brian’s insight: STAR50 Index Rebalance Preview: Big Turnover in a Volatile Market.

In Li Auto (LI US) Dual Primary Listing: HSCI Fast Entry; HSCEI Dec Inclusion & Div Futures Lower Brian expects Li Auto Inc. (LI US) to get Fast Entry to the Hang Seng Composite Index (HSCI) though, as a WVR security, the stock will only be eligible for Stock Connect once it has completed 6 months of listing plus 20 trading days. Li Auto could also be included in the Hang Seng China Enterprises Index (HSCEI INDEX) at the December review. This will lead to a further drop in the HSCEI 2022 dividend futures since we do not expect Li Auto Inc. (LI US) to pay dividends in the near future, while the potential deletion is a higher dividend-yielding stock.

LQ45 Index Rebalance. The IDX has announced the changes to the LQ45 Index as a part of the August review. Barito Pacific (BRPT IJ) and Timah Persero (TINS IJ) have been added to the index while Bank BTPN Syariah (BTPS IJ) and Ciputra Development (CTRA IJ) have been deleted from the index. In  LQ45 Index Rebalance: BRPT, TINS In; BTPS, CTRA Out, Brian expects the impact of passive funds (and active funds) will be quite high on Barito, Bit Digital (BTBT US), and Ciputra and significantly lower on Timah.

MSCI Aug 2021 Index Rebalance Preview. MSCI is scheduled to announce the results of the August 2021 Quarterly Index Review (QIR) on 11 August (early morning of 12 August Asia time) with the changes implemented after the close of trading on 31 August. In  MSCI Aug 2021 Index Rebalance Preview: Potential Changes After Week 1; Positioning at Work, Brian reckons potential inclusions to the MSCI Standard Index are SITC International (1308 HK)Huabao International Holdings (336 HK)Momo.Com Inc (8454 TT)Chinasoft International (354 HK)China United Network A (600050 CH)Ecopro BM Co Ltd (247540 KS)SK IE Technology (361610 KS)CRRC Corp Ltd A (601766 CH),  Beijing Wantai Biological-A (603392 CH)Beijing Kingsoft Office Software-A (688111 CH)Beijing Roborock Technology-A (688169 CH)Imeik Technology Development (300896 CH)StarPower Semiconductor Ltd (603290 CH)Advanced Micro-Fabrication Equipment-A (688012 CH)Ginlong Technologies Co Ltd (300763 CH) and China Baoan (000009 CH). Potential exclusions are Bangkok Bank PCL (BBL/F TB)Bank of East Asia (23 HK)Taiwan Business Bank (2834 TT)KMW Co Ltd (032500 KS)Perennial Energy Holdings Ltd (2798 HK)Douyu International Holdings (DOYU US) and Gaotu Techedu (GOTU US).

OTHER M&A & EVENT UPDATES

CCASS

My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions.  These may be indicative of share pledges.  Or potential takeovers. Or simply help understand volume swings. 

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, lock-up expiry, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

Name

% chg

Into

Out of

Zioncom (8287 HK)30.00%LegoOutside CCASS
Sun King Power Electronics (580 HK) 12.22%CLSAOutside CCASS
China Ecotourism (1371 HK) 19.98%HSBCOutside CCASS
Sheng Ye Capital (6069 HK) 12.78%UBSSinomax
Suncity Group (1383 HK) 74.86%MortonHaitong
Weiye (1570 HK)42.95%HSBCGlory Sun
Niraku Gc Holdings (1245 HK) 31.33%ShenwanOutside CCASS
Source: HKEx

The following large movement(s) concern recently listed companies, and therefore are (likely) lock-up related.


Global Capital Spending: Recovering After Resilience During Pandemic, but Nuances Persist

By Said Desaque

The mainstream financial media mistakenly uses the term of animal spirits to encapsulate all forms of capital spending. While the COVID-19 pandemic temporarily crushed animal spirits, projects receiving prior approval simply had their start dates delayed. Non-commodity capital spending has remained resilient during the pandemic and will register robust gains in 2021.

China’s rise as an economic power means that Asia Pacific corporates are the main contributors to global capital spending, while Europe and North America’s share has declined significantly. Improved commodity prices means that Latin America should register strong capital spending in 2021, while Europe should make its significant improvement since 2006.

Structural factors forcing companies to invest in digital technology and environmentally-friendly production techniques will persist and help to underpin capital spending in the aftermath of the COVID-19 pandemic. Higher capital spending in the semiconductor sector will alleviate product shortages across various end users, but there are fears that higher investment will come on stream after demand rolls over producing another supply glut similar to 2018.

The pandemic has created great hype about the need for companies to invest in intangible assets, thereby further casting doubt on the relevance of the Q-ratio as a measure of equity valuation. US data indicates that equipment and structures still dominate aggregate capital spending and even technology companies need to undertake sizeable investment in tangible assets to conduct business.

Cyclical forces, notably in the US, will also determine the outlook for capital spending, particularly if there are risks of policy mistakes to counter higher inflation. High corporate cash levels have traditionally been supportive for capital spending, but difficulty in finding worthwhile long-term projects since the financial crisis has raised the ante on companies to deploy cash in merger & acquisitions, as well as share buybacks.


Did Passive Rebalancing Trading on SKT Start Last Friday?

By Sanghyun Park

As of last Friday’s closing price, SK Telecom’s foreign ownership burnout rate was 94.93%.

So, the foreign room is 5.07%, a level where the MSCI foreign inclusion factor should be reduced from the current 1.0 to 0.25. It is now almost certain that SKT’s index weight will decrease by 75% in this August QIR.

Post review adjustment factorForeign room (1-FOL burnout)
Current adjustment factor≥ 25%15~25%7.5~15%3.75~7.5%< 3.75%
1.001.001.000.500.250.00
0.501.000.500.500.250.00
0.251.000.500.250.250.00
Source: MSCI

Now, the key question is when will SKT’s passive rebalancing trading start reflecting this situation. In this regard, a fairly significant trade movement was detected last Friday.

Of course, the stock market overall was down last Friday. The KOSPI 200 fell 1.15%. However, SK Telecom declined more significantly than KOSPI 200, and its decline was also visibly larger than its direct peers, KT and LG U+.

What we need to pay more attention to here is the selling trend of foreign investors.

Considering that most of the passive funds that follow MSCI Standard Korea are foreign institutions, the most reasonable indicator that can determine whether rebalancing trading occurs should be overseas investors’ trading patterns.

Then last Friday, net foreign trade became negative for the first time in almost a month, and in particular, this level of net foreign trade (-83,058 shares representing 0.12% of the SO) is the highest since December 10 of last year.


KOSPI200 Index Rebalance Preview: Two Changes in September; Five in December

By Brian Freitas

There could be two changes to the Korea Stock Exchange Kospi 200 Index (KOSPI2 INDEX) at the September index futures expiry with KakaoBank (1349010D KS) and Krafton Inc (259960 KS) getting Fast Entry and replacing Lock&Lock (115390 KS) and Jw Pharmaceutical (001060 KS) at the close of trading on 9 September.

Then, the Korea Exchange (KRX) will announce the results of the December 2021 review of the Korea Stock Exchange Kospi 200 Index (KOSPI2 INDEX) in November. The constituent changes will be effective after the close of trading on 9 December.

We see 5 potential changes at the December rebalance with F&F (383220 KS), SL Corp (005850 KS), GeneOne Life Science Inc. (011000 KS), Myoung Shin Industrial Co.,Ltd (009900 KS) and Hyosung Chemical Corp (298000 KS) replacing F&F Co Ltd (007700 KS), Samyang Foods (003230 KS), Ilyang Pharmaceutical Co., (007570 KS), LX Holdings (383800 KS) and Dongwon F&B (049770 KS).

The potential inclusions have been outperforming the potential exclusions and this could continue as short selling is only permitted on index constituents and as active funds position for the rebalance following excellent returns at the June rebalance.


Afterpay (APT AU) – Square Is Buying Now in an All Stock Deal

By Brian Freitas

The Afterpay Touch (APT AU) stock has taken a beating recently following a lot of negative press about the Buy Now Pay Later (BNPL) industry. This included a Rebel Wilson ad pulled from Australian TV after complaints from consumer protection groups for playing down the risks of taking on debt. Here in New Zealand, there have been calls for greater regulation of BNPL with families struggling to afford basics while paying off the BNPL loans.

Now, Square Inc (SQ US) has announced that it plans to acquire Afterpay Touch (APT AU) in an all-stock deal that values Afterpay at a 30% premium to its last close. Afterpay Touch (APT AU) shareholders will receive 0.375 shares of Square Inc (SQ US) Class A common stock for each Afterpay share they hold on the record date. Square Inc (SQ US) may elect to pay 1% of total consideration in cash. The transaction values Afterpay Touch (APT AU) at A$39bn.

The transaction is expected to close in the first quarter of 2022 subject to shareholder approval, receipt of regulatory approvals and no material adverse effect in relation to Afterpay Touch (APT AU) or Square Inc (SQ US).

Square Inc (SQ US) intends to establish a secondary listing on the ASX to allow Afterpay Touch (APT AU) shareholders to trade Square Inc (SQ US) shares via CHESS Depositary Interests (CDIs) on the ASX. We expect the Square CDIs to be included in the S&P/ASX 200 (AS51 INDEX) replacing Afterpay Touch (APT AU), though the free float on the CDIs will be lower. 


Before it’s here, it’s on Smartkarma

Most Read: WH Group, SK IE Technology, Money Forward, Soho China Ltd, Hyundai Engineering & Const and more

By | Daily Briefs, Most Read

In today’s briefing:

  • WH Group Offer Doc Out – This Little Piggy Went To Market
  • Float Confusions for Likely Adds at MSCI Std Korea QIR: SKIET, Ecopro BM, & Kakao Games
  • TOPIX Inclusion Trade Summary: July 2021
  • Last Week in Event SPACE: SOHO China, Invesco Office, Iress, WH Group, PCCW
  • Hyundai E&C’s Unusual 1P Offering with a Shocking 45% Discount

WH Group Offer Doc Out – This Little Piggy Went To Market

By Travis Lundy

On 6 June 2021, WH Group (288 HK) announced a proposal for a Voluntary Buyback Offer. The company decided it had enough cash and excess capital given its investment requirements and decided to return the excess to shareholders by buying up to 13% of shares outstanding. The Controlling Group would not tender, so they would see their stake increase and the minimum pro-ration would reach nearly 20%. 

The shares popped, then fell. Then they kept on falling. Yesterday and today they hit the level which has been a low point in the oscillator cycle for the last few years at HK$6.00/share.

I wrote about the situation that very day in WH Group Buyback Offer Announced – Strong Accretion Creates Accretion Risk. I wrote that based on then-current pricing, expectations, and the trading levels of its peers, it would not be considered expensive at prices higher than the previous close (which had, to be fair, seen a nice pop on news). 

But markets gonna market. 

The peers fell. DRAMATICALLY. The 7 names in a HK- or China-listed basket of peers have fallen 23% as live hog prices have fallen and the hog/feed ratio has also fallen, indicating hog producers are making even less than before (or, according to the NDRC, losing more than before).

The NEW News – The Offer Doc is Out

Last night, late-ish, WH Group (288 HK) released its Offer Document whereby it launches the Conditional Voluntary Cash Offer for 13% of its own shares at HK$7.80/share. 

  • This will need to be approved by Shareholders – both the Offer and the Whitewash Waiver (the Executive has indicated its intention to approve the WW subject to 50+% of Independent Shareholder votes cast supporting the Offer and 75% of Independent Shareholder votes). 
  • The Record Date for the EGM is 19 August 2021, the EGM is 16 August, and if approved, the Offer will become Unconditional on 16 August and will close on 30 August.
  • Cheques will be sent no later than 8 Sep. Shares not bought back will be returned no later than 9 Sep. 
  • Minimum pro-ration is 19.7%. 

There are things to do here for hedge funds and arbitrageurs.

There are things to do here for long-only funds who love the stock. 

This remains an interesting situation. 

Read on below.


Float Confusions for Likely Adds at MSCI Std Korea QIR: SKIET, Ecopro BM, & Kakao Games

By Sanghyun Park

In MSCI Standard Korea’s QIR rebalancing, likely candidates are narrowed down to the following three stocks.

Today is the last day of the 10-day review period, so the results are almost all out.

The street consensus for the Interim Cutoff is a bit conservative at US$2.8B. Therefore, the full market cap hurdle is ₩5.76T, and the float-adjusted market cap hurdle is ₩2.88T.

Screening
Interim cutoff

₩3,201.7B (US$2.8B)

Full market cap hurdle₩5,763.1B
Float-adjusted market cap hurdle₩2,881.5B
Source: Clepsydra Capital

The problem is the float estimate. At this point, there are different opinions on the floats estimated by the local street.

In all three stocks, accurate float estimation is important enough to determine whether or not they are included in the MSCI Standard this time.

However, none of these three stocks has reached a clear consensus on the float.

All three stocks have passed the full market hurdle. On the other hand, the situation becomes complicated in the case of a float-adjusted market cap hurdle.

The following is whether or not each candidate passed the float-adjusted market cap hurdle at different float rates. As shown below, SKIET needs at least 20%. Ecopro BM needs 50% at a minimum. Kakao Games has the most desperate situation. It needs at least 45%, a substantial boost from the previous 25%.

Potential addsSK IE TechnologyEcopro BMKakao Games
Float rate15.00%20.00%45.00%50.00%25.00%45.00%
Beat the threshold by % – float-adjusted market cap
7. 19-21.69%4.42%-0.83%10.19%-45.54%-1.98%
7. 20-20.58%5.90%-8.09%2.12%-45.67%-2.21%
7. 21-19.83%6.89%-7.71%2.54%-42.76%3.03%
7. 22-14.45%14.07%-8.98%1.13%-35.12%16.79%
7. 23-12.60%16.54%-6.75%3.61%-34.99%17.02%
7. 26-14.82%13.57%-2.44%8.40%-38.49%10.73%
7. 27-15.19%13.08%-2.96%7.83%-37.51%12.48%
7. 28-14.82%13.57%-4.84%5.74%-39.13%9.56%
7. 29-16.49%11.34%-2.65%8.17%-39.39%9.10%
7. 30-15.94%12.09%-0.18%10.91%-41.98%4.43%
Source: KRX

TOPIX Inclusion Trade Summary: July 2021

By Janaghan Jeyakumar, CFA

In this insight, we take a look at the monthly performance of the trading opportunities surrounding TOPIX Index Rebalance events. During the month, we witnessed the Inclusion Events of cloud-based business accounting software company Money Forward (3994 JP), water treatment technology company Nomura Micro Science (6254 JP), and printed circuit board manufacturer Meiko Electronics (6787 JP)

Furthermore, as discussed by Travis Lundy in July TOPIX FFW Rebalancing Trade, there were quarterly float adjustments for some constituents of the TOPIX Index which opened up a few trading opportunities. 

Below is a closer look at each of these situations. 


Last Week in Event SPACE: SOHO China, Invesco Office, Iress, WH Group, PCCW

By David Blennerhassett

Last Week in Event SPACE …

  •  SOHO China Ltd (410 HK)‘s shares were utterly cremated, ostensibly in response to a media report the pre-conditional Offer from the Blackstone Group faces regulatory obstacles. Yet that media article was vague in context, and ultimately stopped short of saying the deal would be blocked. 
  • The Invesco Office J Reit (3298 JP) deal is done. The bidders have 65.07%. This is close enough to win an EGM to consolidate. The bidders could buy more shares on market to get to just under two-thirds, or perhaps even go much higher. There will be index sells first though.
  • The bidding for Australia’s tech companies continues as Iress Ltd (IRE AU) receives an indicative proposal from EQT Fund Management.
  • The Seven Group Holdings (SVW AU) Offer for Boral Ltd (BLD AU) closed late this past week with Seven gaining 69.6%. This prompted some movement on the Board and the close of the Offer will lead to index changes.  
  • The MBO for Sakai Ovex (3408 JP) launched in February and failed in March has now been re-launched, with the activist who effectively blocked the old deal at ¥3000/share now participating in the buyout at ¥3810. It was far from fair the first time around and it is far from fair this time (the activist isn’t selling).
  • WH Group (288 HK)‘s Offer Doc is out. There are things to do here for hedge funds and arbitrageurs. There are things to do here for long-only funds who love the stock. 
  • PCCW Ltd (8 HK) further slims down after entering into a SPA with DigitalBridge Group (DBRG US) to sell its Hong Kong and Malaysian data center businesses for US$750mn. 
  • The Allcargo Logistics (AGLL IN) Delisting Proposal is now “re-initiated” after a SEBI Delistings Regulation change which went into effect last month, not grandfathering in the promoters’ pre-existing Delisting Proposal process. The stock has rallied hard on that news.
  • Plus, other events, CCASS movements, and Mood Spins.

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classifications, and Events – or SPACE – in the past week)

M&A – ASIA

Soho China Ltd (410 HK) (Mkt Cap: $2.0bn; Liquidity: $7mn)

Following a media article, shares were down 31% at one stage, or 48% adrift of the $5.00/share offer price, and 13% below the undisturbed price, before recovering to close at $3.02/share. The article mentions the SOHO China/Blackstone deal has the attention of the Chinese government and is unlikely to face a smooth regulatory approval process in China. In addition, “the deal is expected to face obstacles in obtaining approval, but the issues relate more to the founders, than the deal itself.” The source of the article is understood to be “familiar with the situation”, not working on the deal. For context, I’m familiar with the situation.

  • Apparently, according to the article, Zhang Xin and Pan Shiyi are in the US. We don’t know for how long, or whether this is a recent development. Moreover, there is a question as to whether they need to be in China to be “interviewed” for the deal to complete. One interpretation of this article is the founders need to offer up “something” to get this deal over the line.
  • The current environment is unquestionably one of general risk aversion given all that has happened with Chinese regulators and internet names. SOHO China is a crowded trade and short-term investors are being stopped out, further exacerbating a difficult situation. And being month-end, this is awful timing for many players.
  • Short interest is my biggest concern on the deal. Aggregate short interest on the 9th July was 98.5m shares, with Bloomberg, implying at the time, an additional ~35m short sold since then, or an increase of 35% in the last 2 weeks.  Short sell volume, as a % of total volume, appeared to be ~20-40%. You don’t short something which could be 30% (before yesterday’s move) in your face instantly unless you are certain. Or know something. 
  • This is adding up to one of those “circumstantial evidence” issues. The whole lot could be a circular reference – rumour begets rumour etc. But on balance, this deal should get up. There was clear adding/buying on the big fall day on the pretext this article was weak. The downside to a deal break is now less hairy. If this deal was blocked, for whatever reason, the downside is unlikely to be the undisturbed price, but probably closer to $2.30-ish or 24% down, compared to 66% up to the Offer price. That suggests a 2.75 upside:downside ratio, though where “downside” is can be tricky.

(link to my insight: SOHO China (410 HK): In For a Penny …. )

Invesco Office J Reit (3298 JP) (Mkt Cap: $1.8bn; Liquidity: $24mn)

The bid by the Invesco parent company (Invesco Real Estate and affiliates) for Invesco Office turned out successful, and the bidders gained 5,727,676 units out of the 8,802,650 units out in the float. They now own 65.07% (having started with 6%) so this will end up going to an EGM. Travis Lundy expect cash-out will be received sometime between early December 2021 and late January 2022 but there are weird things which happen. There could be a short squeeze. 

  • There will be index deletions of MSCI, FTSE, and S&P DJI Global in the next several trading days. That should mean a sale of say $180-250mm of stock, though some of it will already be sold in the tender. Some announcements may show up tonight.  There will be a TSEREIT Index deletion which could be US$350-500mm which will happen at the close of the third business day after the EGM decides to consolidate units and delist. 
  • When the deletions happen, there will be buying of the other names in their respective indices.  For the international indices, it is diverse, and non-impactful. For the TSEREIT Index, it should be $350-500mm to buy at the close, which is about 0.7-1.0x ADV of the collective constituents. 
  • Now that this is done, Travis expects the “right” trade is to buy the shares at a decent spread expecting to be able to get one’s JPY 22,750/unit by end of year or early January.  I would want to see a wider spread than where we closed, because there are lots of very wide spreads right now in Asia and risk capital can be better allocated elsewhere.
  • UPDATE:  the TSE announced a hybrid treatment whereby the weight in the TSE REIT Index would be lowered as the FFW dropped from 1.0 to 0.35, effective 31 August 2021. This means a likely index tracking sell of 1.1-1.4mm units at the close of 30 August 2021. The FTSE released their treatment of the downweight which is for unchanged shares in issue total of 8,802,650 and a decreased investability weighting from 97.52559% to 32.4579569576774%. That is a float reduction of 5.73mm shares. That selldown will take place 2 August at the close.

(link to Ttavis insight: Invesco Real Estate Deal for Invesco Office (3298) Successful – Now For the Aftermath)

Iress Ltd (IRE AU) (Mkt Cap: $2.0bn; Liquidity: $6mn)

Trading and wealth management software provider Iress announced it had received a confidential, unsolicited, non-binding, and indicative proposal from Swedish PE outfit EQT Fund Management via a Scheme of Arrangement at a price range of between A$15.30 and A$15.50 cash per share. EQT had previously fielded an Offer of A$14.80/share on the 18 June. Iress’ board unanimously concluded that the Proposal was “conditional and did not represent compelling value for Iress shareholders”. But the board was “prepared to provide it with access to limited non-public information so EQT can develop a proposal that is capable of being recommended to shareholders.”

  • After announcing on the 10 June it had not received any direct approaches, the following day Iress (unprompted it appeared at the time) announced a strategic review, including the divestment of its British mortgage and sales origination business, or MSO; accelerating earnings through M&A, and taking on more debt to buy back shares.  The forward target. In a more detailed strategic review announced today, Iress forecasts an NPAT of ~A$120mn by FY25, up from A$59.1mn in FY20, via “building scale in large addressable market with a focus on the UK, superannuation and investment infrastructure”. 
  • The offer is pitched at a forward EV/EBITDA of 22.4x. This compares to Iress’ five-year forward EV/EBITDA average of 17x. The five-year opener average is 11x, and Iress has traded at a 54% premium to peers over the past five years. 
  • Although the board concluded EQT’s offer did not represent compelling value, it remains engaged with EQT and has provided limited DD.  What price? Roger Sharp took over as Chairman in February and he is known to be a canny dealmaker and wants to leave behind a legacy, and he and the board have a clear intention to building out the business. But a A$17/share bid – 10% above the high-end of EQT’s range – probably garners board support. Even 5% – ~A$16.30 – may get the job done. As it is, EQT’s proposal is already at a life-time high. 

(link to my insight: Iress (ASX AU) Bats Away EQT – For Now)

WH Group (288 HK) (Mkt Cap: $11.8bn; Liquidity: $34mn)

On 6 June 2021, WH Group (288 HK) announced a proposal for a Voluntary Buyback Offer. The company decided it had enough cash and excess capital given its investment requirements and decided to return the excess to shareholders by buying up to 13% of shares outstanding. Then peers fell. DRAMATICALLY. The 7 names in a HK- or China-listed basket of peers have fallen 23% as live hog prices have fallen and the hog/feed ratio has also fallen, indicating hog producers are making even less than before (or, according to the NDRC, losing more than before).

  • WH Group has now released its Offer Document whereby it launches the Conditional Voluntary Cash Offer for 13% of its own shares at HK$7.80/share.  This will need to be approved by Shareholders – both the Offer and the Whitewash Waiver.  The Record Date for the EGM is 19 August 2021, the EGM is 16 August, and if approved, the Offer will become Unconditional on 16 August and will close on 30 August. Cheques will be sent no later than 8 Sep. Shares not bought back will be returned no later than 9 Sep.  The minimum pro-ration is 19.7%. This remains an interesting situation. 
  • Travis is bullish, but too strong a jump post the Offer doc would be a good reason to unwind unless you are VERY bullish the back end vs Peers. 10% higher and the stock is still reasonable to peers on an accretion-adjusted basis, but Peers have fallen a LONG way and they are volatile.  If you are short Peers against WH and hog prices start to go up, then watch out! The Peers came down faster, they can go up faster.  Long-Only investors who like WH Group at the current level should buy 25-30% “extra” of their position using cash and own 125-130% of their position size. At yesterday’s close, that extra 25% position will earn 26%.
  • At the then current price (HK$6.21) Travis liked it outright long and against a Global Basket of Peers. He would shrink the size of the hedge against HK/CH-listed Peers. He would track the Implied Participation Rate levels.  If you are LONG ONLY and you like the stock, there is a great trade to do here. If you are a delta-neutral ARB with no borrow, there is another 5-8% in outperformance before this starts becoming substantially less interesting. If you are a delta-neutral ARB who has oodles of GTNA borrow, you should already be in this with both feet, and you should not get out until the stock goes up a lot.

(link to Travis’ insight: WH Group Offer Doc Out – This Little Piggy Went To Market)

Spark Infrastructure (SKI AU)  (Mkt Cap: $3.5bn; Liquidity: $7mn)

After rejecting two take-private proposals from PR outfit firm KKR and Ontario Teachers’ Pension Plan Board (OTPPB), Aussie poles and wires company Spark has ostensibly supported the Consortium’s improved tilt of $2.95/share. The Consortium (KKR/OTPPB)’s latest proposal, up from the initial Offer of $2.70/share, was considered by Spark’s board to be in the interest of its shareholders to engage further. As such, Spark has provided the Consortium with due diligence on a non-exclusive basis. This Offer remains pre-conditional, and is subject to satisfactory DD, together with board approval from both KKR and OTPPB. A firm Offer, should one unfold, would be subject to FIRB approval, and the approval from Spark’s shareholders at a Scheme Meeting. Yet this looks like a full (er) Offer than the one rejected on the 15 July.

  • The assets held by Spark are regulated. You could go further and say Spark simply collects dividends from its minority stakes. Electricity assets are designated critical assets by the FIRB-affiliate Critical Infrastructure Center. But these minority holdings should help facilitate the FIRB application. The trickier aspect of the application is that 100% of SA Power/Victoria Power Networks would be controlled by foreign investors if this deal get up.
  •  The Offer is pitched at ~1.6x regulatory asset base. The RAB multiple for the failed APA Group (APA AU) tilt from CK Infrastructure Holdings (1038 HK) was also estimated at 1.6x. DUET Group (DUE AU) was taken out by CKI in 2017 at ~1.4x.
  • An interloper is possible. . APA remains close with CKI, despite the failed bid in 2018. Plus, this would keep the minority interest stakes in Australian hands.  But again, given Spark’s minority stakes, any successful suitor will not have unfettered control over these utilities.

Sakai Ovex (3408 JP)  (Mkt Cap: $0.2bn; Liquidity: $1mn)

In early February 2021, the CEO of Sakai Ovex (3408 JP), who owned very few shares, and an activist investor decided to launch an MBO for the company at ¥2,850/share.  The stock had been trading cheap, and the price was “high” but the price was wrong. It needed to be 40% higher – at a minimum – in my opinion. Not long after that, the bidders offered a very weak bump to ¥3,000/share, discussed in Savai Ovex MBO – A Very Weak Bump. This was not enough. The shares traded above terms and revised terms, only falling below when the Tender Offer went ex-. 

  • The Bidders are back. And now City Index Eleventh is joining them. It pays to be the fulcrum investor.  And now they are bidding ¥3,810. Which is still cheap.  The president, who holds almost no shares, and a value/activist investor have proposed to take the company private at a discount to book, with considerable non-operating assets and earnings.  There is a lot of value hidden in the details.  This deal was short by probably ¥1,200/share the first time which would have taken it to ¥4,000/share. I personally think it is still short. Perhaps another ¥800-1000/share would be better. 
  • The insiders have about 50% of the shares locked up with Murakami-san. They need about a third of the rest.  This will be incrementally tougher to block, but those who do more digging and decide they too would like to become an equity partner in the takeout, there is actually a possible role for you.
  • Travis would buy at or just below tender offer price. He thinks this gets done. If someone shows up BIGLY there could still be a small bump.

(link to Travis’ insight: Sakai Ovex MBO Reloaded – Up 27% from Last Weak Bump But Still Cheap)

After wood flooring manufacturer Nature Home Holding Company (2083 HK) was suspended on the 19 July, in Nature Home (2083 HK): Possible Takeover Target I concluded if an Offer was to be tabled, it would likely be via a Scheme and at ~HK$1.70/share. And this is exactly what transpired. Nature Home announced an Offer from its founding shareholders, by way of a Scheme, at HK$1.70/share. The Offer Price will not be increased. Dehua Tb New Decoration A (002043 CH) has given an irrevocable rollover undertaking for its 19.6% stake. Standard Scheme conditions apply. On account of the Rollover Agreement, Dehua does not form part of the independent shareholders who will vote on the merits of the Scheme. This Offer looks done. Link to my insight: Nature Home (2083 HK)’s Full Offer.

Advantest Corp (6857 JP) had a good Q1 and revised up its full year. The company also announced a buyback of up to 10mm shares and up to ¥70bn through March next year. Given the current share price, that would only get ~7 million shares bought back but while that is only 3.5% of shares out ex-Treasury, it is 10+% of Real World Float. In Breaking Down Advantest’s Big Buyback, Travis expects that this buyback will contribute to positive/better/high-quality momentum (price and outperformance) on a stock which already has decent momentum both on stock price and fundamentals. 

On the 30 April, aged-care Australian listed operator Japara Healthcare (JHC AU) announced it had received an unsolicited, indicative, conditional, and non-binding Offer from Little Company of Mary Health Care – otherwise known as Calvary – by way of a Scheme, at A$1.04/share. On the 5 June, Calvary increased the indicative Offer price to A$1.20/share.  On the 15 June, the Bolton Clarke Group made a conditional, non-binding indicative proposal by way of a Scheme, at A$1.22/share. JHC has now announced that it has entered into a Scheme Implementation Deed (SID) with Calvary, by way of a Scheme at A$1.40/share. The consideration will be reduced by any dividends paid.  JHC’s board of directors have unanimously recommended the Scheme, in the absence of a superior proposal and subject to an independent expert concluding the Scheme is fair & reasonable. This looks done. Link to my insight: Japara Healthcare (JHC): Calvary Takes Charge.

India-based integrated logistics company Allcargo Logistics (AGLL IN) received a “Delisting Proposal” from its Promoter Group (Shashi Kiran Shetty and Talentos Entertainment Private Limited) in August 2020. Since then, the stock has gained more than 70%. Despite the rally since the Initial Delisting Proposal, Allcargo is not too expensive strictly from a fundamental angle. Going by LTM numbers, Allcargo is trading at a EV/EBITDA of 9.5x which looks cheap when considering that EBITDA CAGR for FY21A-FY23E is ~26% according to Capital IQ consensus.  In Allcargo (AGLL IN): Process Reinitiated! 70%+ Up Now. Should You Still Chase?. Read more: https://skr.ma/xDxmq, Janaghan Jeyakumar expects the Deal to complete. He would be cautious about chasing. However, he would expect dips are good to be bought.  

On the 18 May, Yue Xiu (the investment arm of the Guangzhou municipal government) made an Offer, by way of a Scheme, for Chong Hing Bank (1111 HK) shares not owned, at HK$20.80/share, a 51.2% premium to last close, and a 97% premium to the day preceding the last trading day. The Cancellation Price, which was a 10.1% discount to the NAV, would NOT be increased. Standard Scheme conditions apply. Chong Hing is Hong Kong incorporated, therefore there is no headcount test. The Scheme Document is now out.  The Scheme Meeting will be held on the 30 August with expected payment (assuming the Scheme resolutions are approved by independent shareholders) on the 7 October. The IFA considers the Offer to be fair and reasonable, although that report covered the bare minimum. Link to my insight: Chong Hing Bank (1111 HK): Scheme Doc Out. IFA Says Fair.

STUBS

PCCW Ltd (8 HK) / HKT Ltd (6823 HK) 

At the time of my insight, I had the discount to NAV at ~23%, compared to the 12-month average of 17%. The implied stub of (HK$1.20/share) compares to the (HK$1.05/share) average since PCCW reduced its take in HKT back in February 2017.  The simple ratio (PCCW/HKT) of 0.4x compares to the 0.42x average since the February 2017 reduction. 

  • PCCW Solutions operates 9 data center locations in Hong Kong, China, and Malaysia. The portfolio comprises ~75+ megawatts of power capacity, across 1.3mn sqft of GFA.  This portfolio of data centers made a net profit of US$2.6mn in FY20, up from US$0.02mn in FY19. Net assets are ~US$258.3mn, therefore DigitalBridge is paying  288x trailing earnings, and 2.9x book. PCCW appears to have paid 1.9x P/B for the Malaysian ops last year.
  • I think one of two events will ultimately transpire from hereon – either HKT is taken over – not by PCCW – but by a PRC telecommunication company such as China United Network A (600050 CH), which already holds 18.5% – HK media assets have gradually been snapped up by PRC buyers; or Richard Li attempts another privatisation of PCCW.
  • That’s not to say Richard wants to continue in his dad’s footsteps by holding or acquiring telco assets. I think he wants the cash from the sale of PCCW’s stake in HKT. Following the sale of the data centers, PCCW would be net cash, or thereabouts, at the parent level. Richard has been in the news lately concerning Southeast Asian online realty company PropertyGuru agreeing to go public through a merger with a blank-check firm backed by Richard and Peter Thiel. But Richard’s passion in recent years appears to evolve around insurance, especially the soon (expected)-to-be listed FWD.
  • I would be inclined to be invested where Richard is – and therefore be Long PCCW, short HKT here. I expect the NAV discount to narrow towards its one-year average. 

(link to my insight: StubWorld: The Trimming Of PCCW

Zhen Zhou, Toh is not particularly excited about Del Monte Philippines (1575316D PM)’s business because revenue growth will likely taper off as COVID-19 situation eases and further margin expansion too seems unlikely. In Del Monte Pacific HoldCo Trade Update – A Better Play for Del Monte PH IPO, he thinks that the better way to trade the IPO is to buy DMPL with the expectation that the IPO will go through. And even though liquidity isn’t great, which could mean that Del Monte Pacific (DELM SP) will trade at a deeper holdco discount, there is still potential upside to be realized at those levels.

EVENTS

JAPAN PASSIVE: Who Owns What 2021?

Passive holdings in Japan are approximately equal to 30-34% of the “float” as calculated by index providers such as MSCI, FTSE, and the TSE float calculations (which are generally smaller than MSCI and FTSE) PLUS 28-31,000 baskets worth of Nikkei 225 holdings. Longer-term, this fluctuates in the range of 26-30 million shares. This really matters with names with low share count. But among TOPIX 1000 names which are members, it is a weighted average of just over 4%.

  • That puts Fanuc Corp (6954 JP) and Tokyo Electron Ltd (8035 JP) in the 38-45% range of float, if not a little higher. TDK Corp (6762 JP)Cyberagent Inc (4751 JP)Nissan Chemical Industries (4021 JP), and Kikkoman Corp (2801 JP) are in the 42-50+% range. Konami Holdings Corp (9766 JP) and Hitachi Construction Machinery (6305 JP) are close to or above 50%. Fast Retailing Co Ltd (9983 JP) is likely well above 70%.
  • Last year Travis said “The BOJ may change its ETF allocations.” It did. It stopped buying Nikkei 225 and JPX Nikkei 400 ETFs.
  • As the world moves more and more to passive, expect float to decrease. As companies continue buying back stock, pay attention as to whether it is being repurchased from the market or from designated non-float sellers.
  • Changes to the TSE Market Structure may introduce significant changes to index constituency impact on smallcap shares within the TSE First Section. It will likely not mean much at all for large cap shares.  Many companies are looking at optimising their shareholding structure to make it possible for them to be TSE Prime members.
  • In many cases, there are efforts to reduce cross-holdings because of increased emphasis on that factor exercised by the revised Corporate Governance Code and by new voting policies implemented this year by Glass Lewis and ISS which will recommend votes against directors where more than 10% or 20% of equity value is locked up in cross-holdings. 

(link to Travis’ insight: JAPAN PASSIVE: Who Owns What 2021?)

In China’s New After-School Tutoring Policy Is Out – The End of the Line For Many?, Travis reckons the operating businesses for after-school edcuati0n stocks are likely to be worth almost nothing. The only way they survive as economic entities is to pivot to other training, or to pivot to supporting the national cause. Spin off the teachers and the organizational structure of what they do into an Opinion-compliant construct. Provide it with a little seed capital. Then keep whatever online tech one has and make the tech a fee-earning business.  If it were him, in their shoes, he would be making plans to pivot today.  If any of these tycoons end up with any remaining wealth, that is good for them. He thinks the stocks are a really, really tough thing to own other than for break-up value. Osbert Tang also discussed this situation in China Private Education: How to Position After the Regulatory Crackdown? 

Full Circulation Of H-Shares: July 2021 Update was latest update in a series dating back to Legend’s Conversion of Domestic Shares in June 2018.

  • To date, 28 companies have sought approval to convert their domestic shares and/or unlisted foreign shares into H shares, which would then be eligible to be listed and traded on Hong Kong’s stock exchange.
  • 16 companies have now been given CSRC and Hong Kong listing approval to convert such shares. Five of those have seen various degrees of movement in the converted shares.
  • Sichuan Languang Justbon Service Group (2606 HK) received approval late last year but did not convert – and was subsequently subject to an Offer.
  • To date, two companies have withdrawn their application to convert their domestic shares.  Both of these companies –  Beijing Capital Land Ltd H (2868 HK) and Zhejiang Cangnan Instrument (1743 HK) have now been subject to Offers.

TOPIX INCLUSIONS!

In TOPIX Inclusion Trade Summary: July 2021, Janaghan took a look at the monthly performance of the trading opportunities surrounding TOPIX Index Rebalance events. During the month, we witnessed the Inclusion Events of cloud-based business accounting software company Money Forward (3994 JP), water treatment technology company Nomura Micro Science (6254 JP), and printed circuit board manufacturer Meiko Electronics (6787 JP).  Furthermore, as discussed by Travis in July TOPIX FFW Rebalancing Trade (see above), there were quarterly float adjustments for some constituents of the TOPIX Index which opened up a few trading opportunities. 

M&A – EUROPE

Naturgy Energy Group SA (NTGY SM) is awaiting the decision to be made by the Government on the partial takeover launched by the Australian fund IFM for 22.7% of the capital. The success of IFM’s partial takeover attempt is becoming increasingly difficult due to a delay in the approval of the takeover by the Spanish Government; and Criteria Caixa’s intentions to strengthen its shareholding in Naturgy. Criteria Caixa already holds 25.997%. Assuming it will still purchase up to 29.9%, that is a 3.903% stake pending, some 37.84 mn shares, i.e. approximately €826 mn (at the closing price of 29 July) almost worth the volume of 50 trading sessions (at the last three months average daily volume). Link to Jesus Rodriguez Aguilar‘s insight: IFM/Naturgy: New Developments.
Unicaja Banco SA (UNI SM) and Liberbank SA (LBK SM) will soon finalize their merger after receiving all the authorisations. On 19 July, the Spanish Government gave the green-light to the integration, which is expected to close on 30 July. Liberbank’s shares are trading at a 0.8% discount (adjusted for the merger ratio). Although liquidity is thin, in Unicaja/Liberbank: Final Stretch Jesus recommends a short UNI SM/long LBK SM. The effective merger is highly likely to happen on 30 July.
On 21 July, Bloomberg reported that Canadian Brookfield Asset Management-Cl A (BAM/A CN) was working with advisers as it considers a potential bid for alstria office reit-ag (AOX GR). In Brookfield/Alstria Office REIT: Potential Takeover, Jesus reckons a takeout price could come in at €18.68, a 10% premium over the last reported EPRA NTA and 6.4% premium to the closing price on 23 July. 

M&A – US

In SpinTalk: More Value To Be Had In Now Imminent XPO Logistics Break-Up, Robert Sassoon revisited the proposed break-up of Xpo Logistics (XPO US). This corporate event is now just a few days away and will be executed via  the tax-free spin-off of the logistics business GXO Logistics (GXO US) on August 2, 2021, effected through a 1-for-1 distribution of new GXO shares to XPO shareholders

PAIRS

Roland Corp (7944 JP) Has been shifting production away from China and Japan to concentrate most of the production activities to the Malaysian plant established in 2014 as a part of the business turnaround process that followed a vicious downward spiral in the post-global financial crisis environment. While demand for musical instruments soars across the world, COVID-19 lockdowns in Malaysia continues to affect Roland’s production capabilities. In Short Roland/Long Yamaha as Roland May Fail to Meet Demand Due to Production Shortages, Oshadhi Kumarasiri believes Roland may fail to meet demand amidst disruptions to the main production facility in Malaysia while Yamaha Corp (7951 JP) seems to be well placed to outperform the market through capturing Roland’s lost demand.

INDEX REBALS

With Gulf Energy Development Public Company (GULF TB)‘s Offer for Intouch Holdings (INTUCH TB) closing next week, in GULF/INTUCH: Nearing The End of the Offer Period; Passive Selling to Come, Brian Freitas expects FTSE and MSCI to lower Intouch’s investability weight/ FIF over the next week due to a drop in the free float and this will necessitate passive selling on the stock.

In Kakao Bank: Allocations, Lock Ups and Index Fast Entry, Brian sees KakaoBank (1349010D KS) as a high probability inclusion in the Korea Stock Exchange Kospi 200 Index (KOSPI2 INDEX) with the implementation at the close of trading on 9 September.

At the IPO price, Krafton Inc (259960 KS) should get MSCI Fast Entry if less than 30% of the institutional allocation is locked up, while the stock should get FTSE Fast Entry even with 50% of the institutional allocation locked up. If a higher percentage of shares is locked up, the stock will need to close higher on listing day to get index Fast Entry. Link to Brian’s insight: Krafton IPO: Bookbuilding Results & Index Fast Entry.

STAR50 Index Rebalance Preview. With only 2 trading days left in the review period, Brian sees Shanghai Shen Lian Biomedical (688098 CH)Piesat Information Technology (688066 CH)Guangzhou Fang Bang Electr-A (688020 CH)Shenzhen Lifotronic Techno-A (688389 CH), and Appotronics Corp Ltd (688007 CH) as high probability deletions from the index. Link to Brian’s insight: STAR50 Index Rebalance Preview: Big Turnover in a Volatile Market.

In Li Auto (LI US) Dual Primary Listing: HSCI Fast Entry; HSCEI Dec Inclusion & Div Futures Lower Brian expects Li Auto Inc. (LI US) to get Fast Entry to the Hang Seng Composite Index (HSCI) though, as a WVR security, the stock will only be eligible for Stock Connect once it has completed 6 months of listing plus 20 trading days. Li Auto could also be included in the Hang Seng China Enterprises Index (HSCEI INDEX) at the December review. This will lead to a further drop in the HSCEI 2022 dividend futures since we do not expect Li Auto Inc. (LI US) to pay dividends in the near future, while the potential deletion is a higher dividend-yielding stock.

LQ45 Index Rebalance. The IDX has announced the changes to the LQ45 Index as a part of the August review. Barito Pacific (BRPT IJ) and Timah Persero (TINS IJ) have been added to the index while Bank BTPN Syariah (BTPS IJ) and Ciputra Development (CTRA IJ) have been deleted from the index. In  LQ45 Index Rebalance: BRPT, TINS In; BTPS, CTRA Out, Brian expects the impact of passive funds (and active funds) will be quite high on Barito, Bit Digital (BTBT US), and Ciputra and significantly lower on Timah.

MSCI Aug 2021 Index Rebalance Preview. MSCI is scheduled to announce the results of the August 2021 Quarterly Index Review (QIR) on 11 August (early morning of 12 August Asia time) with the changes implemented after the close of trading on 31 August. In  MSCI Aug 2021 Index Rebalance Preview: Potential Changes After Week 1; Positioning at Work, Brian reckons potential inclusions to the MSCI Standard Index are SITC International (1308 HK)Huabao International Holdings (336 HK)Momo.Com Inc (8454 TT)Chinasoft International (354 HK)China United Network A (600050 CH)Ecopro BM Co Ltd (247540 KS)SK IE Technology (361610 KS)CRRC Corp Ltd A (601766 CH),  Beijing Wantai Biological-A (603392 CH)Beijing Kingsoft Office Software-A (688111 CH)Beijing Roborock Technology-A (688169 CH)Imeik Technology Development (300896 CH)StarPower Semiconductor Ltd (603290 CH)Advanced Micro-Fabrication Equipment-A (688012 CH)Ginlong Technologies Co Ltd (300763 CH) and China Baoan (000009 CH). Potential exclusions are Bangkok Bank PCL (BBL/F TB)Bank of East Asia (23 HK)Taiwan Business Bank (2834 TT)KMW Co Ltd (032500 KS)Perennial Energy Holdings Ltd (2798 HK)Douyu International Holdings (DOYU US) and Gaotu Techedu (GOTU US).

OTHER M&A & EVENT UPDATES

CCASS

My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions.  These may be indicative of share pledges.  Or potential takeovers. Or simply help understand volume swings. 

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, lock-up expiry, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

Name

% chg

Into

Out of

Zioncom (8287 HK)30.00%LegoOutside CCASS
Sun King Power Electronics (580 HK) 12.22%CLSAOutside CCASS
China Ecotourism (1371 HK) 19.98%HSBCOutside CCASS
Sheng Ye Capital (6069 HK) 12.78%UBSSinomax
Suncity Group (1383 HK) 74.86%MortonHaitong
Weiye (1570 HK)42.95%HSBCGlory Sun
Niraku Gc Holdings (1245 HK) 31.33%ShenwanOutside CCASS
Source: HKEx

The following large movement(s) concern recently listed companies, and therefore are (likely) lock-up related.


Hyundai E&C’s Unusual 1P Offering with a Shocking 45% Discount

By Sanghyun Park

Offering overview

A very unusual rights offering was recently announced in the Korean market.

Hyundai E&C announced this unusual capital increase, saying it would issue 2 million new preferred stocks.

Overview
Shares to be issuedHyundai Engineering & Construction Co. Preference Shares
Ticker000725
TargetA public offering of forfeited shares after offering to stockholders
TransferabilityRenounceable
Volume2,000,000
Preliminary price₩114,500
Preliminary value₩229,000,000,000
Oversubscription privilege20.00%
BankerKIS & Hyundai Motor Securities
Source: DART

Although the capital increase ratio resulting from these 2 million shares remains at 1.79%, the offering volume is 20 times the size of the currently issued preferred stock.

Capital increase rate
Ordinary – before rights offer111,355,765
Pref – before rights offer98,856
Offer volume2,000,000
Capital increase rate1.79%
Total shares after rights offer113,454,621
– Ordinary111,355,765
– Pref2,098,856
Source: DART

And what’s even more shocking is that the discount rate applied when calculating the final offering price is a whopping 45%.

For local rights offerings, a discount rate of 15-20% is usually applied. In contrast, this rights offering applies a discount rate of more than double the usual level.

Pricing
1st roundRP × (1 – 45%) / [1 + (1.79% × 45%)]
– Reference price (RP)Min [Close, Avg (Close, 1W VWAP, 1M VWAP)]
– Reference date2021. 08. 30
Ex-rights base price[RP + (1st × 1.79%)] / (1 + 1.79%)
– Reference price (RP)Previous close
– Reference date2021. 09. 01
2nd roundRP × (1 – 45%)
– Reference price (RP)Min [Close, Avg (Close, 1W VWAP)]
– Reference date2021. 10. 18
FinalMin (1st, 2nd)
– Reference date2021. 10. 18
Discount rate45.00%
Capital increase rate1.79%
Source: DART

In this rights offering, 20% will be allocated to the ESOP, and the remaining 80% will be allocated to shareholders.

Of course, not only shareholders who own preferred stocks but also shareholders who own common stocks are given the same purchase rights. So the allocation ratio per share becomes 0.0143556.

Allocation
Per-share allocation0.0143556
ESOP allocation400,000
– %20.00%
Stockholder allocation1,600,000
– %80.00%
Source: DART

The schedule is as follows. The first-round price is confirmed on Aug. 30, and this becomes the ceiling of the offering price. And since September 1 is the ex-date, the stock must be held by August 31 to be granted the subscription right. After that, the subscription rights will be traded for 5 trading days from October 1 to 8, and the final price will be confirmed on October 18. The new stock listing date is November 5.

Timetable
BOD meeting2021. 07. 23
Preliminary pricing2021. 08. 30
Ex-rights date2021. 09. 01
Record date2021. 09. 02
Subscription rights trade beginning2021. 10. 01
Subscription rights trade ending2021. 10. 08
Final pricing2021. 10. 18
Stockholder subscription2021. 10. 21
Payment2021. 10. 26
Listing2021. 11. 05
Source: DART

Before it’s here, it’s on Smartkarma

Most Read: Beijing Huafeng Test & Control Technology-A, Soho China Ltd, WH Group, Intouch Holdings, KakaoBank and more

By | Daily Briefs, Most Read

In today’s briefing:

  • STAR50 Index Rebalance Preview: Big Turnover in a Volatile Market
  • SOHO China (410 HK): In For a Penny …
  • WH Group Offer Doc Out – This Little Piggy Went To Market
  • GULF/INTUCH: Nearing The End of the Offer Period; Passive Selling to Come
  • Kakao Bank: Allocations, Lock Ups and Index Fast Entry

STAR50 Index Rebalance Preview: Big Turnover in a Volatile Market

By Brian Freitas

The SSE STAR 50 (STAR50 INDEX) is a free float market cap weighted and is made up of the 50 largest stocks based on full market cap that are listed on the STAR Market.

The review period for the September rebalance ends on 31 July, the results of the rebalance will be announced towards the end of August and the changes will be implemented at the close of trading on 10 September.

With only 2 trading days left in the review period, we see Shanghai Shen Lian Biomedical (688098 CH)Piesat Information Technology (688066 CH)Guangzhou Fang Bang Electr-A (688020 CH)Shenzhen Lifotronic Techno-A (688389 CH) and Appotronics Corp Ltd (688007 CH) as high probability deletions from the index.

Coming up with a definitive list of inclusions is tougher given the subjectivity of the index rules for this review. The subjectivity comes from the whether the index committee uses a minimum listing history period of 12 months or 6 months.

Higher probability inclusions (if a 12 month minimum listing history is used) are Eyebright Medical Technology Beijing (688050 CH), Sinocelltech Group (688520 CH), Beijing Huafeng Test & Control Technology-A (688200 CH), Zhejiang Orient Gene Biotech-A (688298 CH) and Tinavi Medical Technologies (688277 CH).

Lower probability inclusions (if a 6 month minimum listing history is used) are Zhejiang Supcon Technology (688777 CH), Tianneng Battery Group (688819 CH), Bestechnic Shanghai (688608 CH), 3peak (688536 CH) and Pylon Technologies Co Ltd (688063 CH).

The inclusions, exclusions and capping changes will result in a one-way turnover of 8.45% and result in a one-way trade of CNY3.3bn.


SOHO China (410 HK): In For a Penny …

By David Blennerhassett

Yesterday, SOHO China Ltd (410 HK)‘s shares were utterly cremated, ostensibly in response to a media report the pre-conditional Offer from the Blackstone Group faces regulatory obstacles.

At one stage, shares were down 31%, or 48% adrift of the $5.00/share offer price, and 13% below the undisturbed price, before recovering to close at $3.02/share.

Yet that media article was vague in context, and ultimately stopped short of saying the deal would be blocked. 

As they say, “In for a penny, in for a pound.”

More thoughts below the fold.


WH Group Offer Doc Out – This Little Piggy Went To Market

By Travis Lundy

On 6 June 2021, WH Group (288 HK) announced a proposal for a Voluntary Buyback Offer. The company decided it had enough cash and excess capital given its investment requirements and decided to return the excess to shareholders by buying up to 13% of shares outstanding. The Controlling Group would not tender, so they would see their stake increase and the minimum pro-ration would reach nearly 20%. 

The shares popped, then fell. Then they kept on falling. Yesterday and today they hit the level which has been a low point in the oscillator cycle for the last few years at HK$6.00/share.

I wrote about the situation that very day in WH Group Buyback Offer Announced – Strong Accretion Creates Accretion Risk. I wrote that based on then-current pricing, expectations, and the trading levels of its peers, it would not be considered expensive at prices higher than the previous close (which had, to be fair, seen a nice pop on news). 

But markets gonna market. 

The peers fell. DRAMATICALLY. The 7 names in a HK- or China-listed basket of peers have fallen 23% as live hog prices have fallen and the hog/feed ratio has also fallen, indicating hog producers are making even less than before (or, according to the NDRC, losing more than before).

The NEW News – The Offer Doc is Out

Last night, late-ish, WH Group (288 HK) released its Offer Document whereby it launches the Conditional Voluntary Cash Offer for 13% of its own shares at HK$7.80/share. 

  • This will need to be approved by Shareholders – both the Offer and the Whitewash Waiver (the Executive has indicated its intention to approve the WW subject to 50+% of Independent Shareholder votes cast supporting the Offer and 75% of Independent Shareholder votes). 
  • The Record Date for the EGM is 19 August 2021, the EGM is 16 August, and if approved, the Offer will become Unconditional on 16 August and will close on 30 August.
  • Cheques will be sent no later than 8 Sep. Shares not bought back will be returned no later than 9 Sep. 
  • Minimum pro-ration is 19.7%. 

There are things to do here for hedge funds and arbitrageurs.

There are things to do here for long-only funds who love the stock. 

This remains an interesting situation. 

Read on below.


GULF/INTUCH: Nearing The End of the Offer Period; Passive Selling to Come

By Brian Freitas

On 19 April, Gulf Energy Development Public Company (GULF TB) made a conditional voluntary tender offer for all shares in Intouch Holdings (INTUCH TB) that it did not hold at THB 65/share. The Offer Period commenced on 29 June and will end on 4 August at 4pm.

Post market close yesterday, Gulf Energy Development Public Company (GULF TB) announced that 318.154m shares (9.92% of the issued shares) of Intouch Holdings (INTUCH TB) have been tendered as of 27 July taking their holding in the company up to 28.85%. This could move higher by the close of trading on 4 August.

We expect FTSE and MSCI to lower Intouch Holdings (INTUCH TB)‘s investability weight/ FIF over the next week due to a drop in the free float and this will necessitate passive selling on the stock. 


Kakao Bank: Allocations, Lock Ups and Index Fast Entry

By Brian Freitas

KakaoBank (1349010D KS) announced the IPO allocations and voluntary lock-ups on the institutional investor allocation yesterday. The company raised US$2.23bn by selling 65.45m shares at KRW 39,000/share, valuing KakaoBank (1349010D KS) at US$16.21bn.

Due to undersubscription, there was a small reallocation from the ESOP category to institutional and retail investors. 60% of the institutional investor allocation is subject to lock ups.

KakaoBank (1349010D KS) is a high probability inclusion in the Korea Stock Exchange Kospi 200 Index (KOSPI2 INDEX) with the implementation at the close of trading on 9 September.

With the free float at 6.56%, Fast Entry inclusion in the FTSE All-World and MSCI Standard index will require a big listing pop for the stock. Given the concern on the stock being overvalued at the IPO price, a big jump is unlikely on listing day and we do not expect Fast Entry inclusion for KakaoBank (1349010D KS).

Trading at a big premium to the traditional banks, with a large number of pre-IPO investors able to sell from listing day, and the lack of large passive buying flow, the stock could trade weaker than similar listings in the recent past.


Before it’s here, it’s on Smartkarma

Most Read: Beijing Huafeng Test & Control Technology-A, KakaoBank, Krafton Inc, Iress Ltd, Myoung Shin Industrial Co.,Ltd and more

By | Daily Briefs, Most Read

In today’s briefing:

  • STAR50 Index Rebalance Preview: Big Turnover in a Volatile Market
  • Kakao Bank – Gray Market Price Declines Sharply By 35% in One Month
  • Krafton IPO: Bookbuilding Results & Index Fast Entry
  • Iress (ASX AU) Bats Away EQT – For Now
  • KRX Autos Rebalancing on September 9: Watch Myoungshin Industrial as a New Add

STAR50 Index Rebalance Preview: Big Turnover in a Volatile Market

By Brian Freitas

The SSE STAR 50 (STAR50 INDEX) is a free float market cap weighted and is made up of the 50 largest stocks based on full market cap that are listed on the STAR Market.

The review period for the September rebalance ends on 31 July, the results of the rebalance will be announced towards the end of August and the changes will be implemented at the close of trading on 10 September.

With only 2 trading days left in the review period, we see Shanghai Shen Lian Biomedical (688098 CH)Piesat Information Technology (688066 CH)Guangzhou Fang Bang Electr-A (688020 CH)Shenzhen Lifotronic Techno-A (688389 CH) and Appotronics Corp Ltd (688007 CH) as high probability deletions from the index.

Coming up with a definitive list of inclusions is tougher given the subjectivity of the index rules for this review. The subjectivity comes from the whether the index committee uses a minimum listing history period of 12 months or 6 months.

Higher probability inclusions (if a 12 month minimum listing history is used) are Eyebright Medical Technology Beijing (688050 CH), Sinocelltech Group (688520 CH), Beijing Huafeng Test & Control Technology-A (688200 CH), Zhejiang Orient Gene Biotech-A (688298 CH) and Tinavi Medical Technologies (688277 CH).

Lower probability inclusions (if a 6 month minimum listing history is used) are Zhejiang Supcon Technology (688777 CH), Tianneng Battery Group (688819 CH), Bestechnic Shanghai (688608 CH), 3peak (688536 CH) and Pylon Technologies Co Ltd (688063 CH).

The inclusions, exclusions and capping changes will result in a one-way turnover of 8.45% and result in a one-way trade of CNY3.3bn.


Kakao Bank – Gray Market Price Declines Sharply By 35% in One Month

By Douglas Kim

The gray market price of Kakao Bank has declined sharply by nearly 35% in the past month. As of 28 July 2021, Kakao Bank’s gray market price is 55,000 won, down from 85,000 won about a month ago. Typically, gray market prices of major Korean IPOs (those that have market caps of more than 1 trillion won) do not change this much within a short period of time. Kakao Bank IPO is scheduled to start trading on August 6th. 

Our base case valuation of Kakao Bank remains market cap of 26.8 trillion won or implied price of 56,144 won per share. This represents 44% higher than the high end of the IPO price range of 39,000 won. We continue to maintain a POSITIVE view of Kakao Bank, given the solid upside relative to the IPO price.

Nonetheless, given the sharp decline in the recent gray market price of Kakao Bank, there is now a reduced likelihood of Kakao Bank’s share price rising significantly to the 75,000 won to 85,000 won level in the first few hours of trading on August 6th. 


Krafton IPO: Bookbuilding Results & Index Fast Entry

By Brian Freitas

A short while ago, Krafton Inc (259960 KS) disclosed the results of its institutional book building and confirmed that the offer price has been set at KRW 498,000/share, the high end of the IPO range.

Bids came in for 1.157bn shares resulting in an oversubscription of 243 times the shares offered to institutions with domestics outbidding foreign investors in terms of number of shares. Bids at or above KRW 498,000 came from 95% of the shares that were bid for.

78% of the shares that were bid for came with a no lock-up commitment. Allocations that match the results of the bookbuilding will increase the free float of the stock making it easier for index Fast Entry. At the same time, there could be a lot of selling pressure as retail, institutions and pre-IPO investors all try to exit in the first few trading days.

Korea Stock Exchange Kospi 200 Index (KOSPI2 INDEX) Fast Entry at the September futures expiry should be easy. At the IPO price, Krafton Inc (259960 KS) should get MSCI Fast Entry if less than 30% of the institutional allocation is locked up, while the stock should get FTSE Fast Entry even with 50% of the institutional allocation locked up. If a higher percentage of shares is locked up, the stock will need to close higher on listing day to get index Fast Entry.

With a large number of shares not subject to lock-ups, there could be selling on listing day. The stock should then stabilize and move higher on expectation of passive buying from FTSE and MSCI trackers. The stock could then drift lower before picking up ahead of the inclusion in the Korea Stock Exchange Kospi 200 Index (KOSPI2 INDEX)


Iress (ASX AU) Bats Away EQT – For Now

By David Blennerhassett

The bidding for companies in Australia’s technology sector continues.

Trading and wealth management software provider Iress Ltd (IRE AU) announced this morning it had received a confidential, unsolicited, non-binding, and indicative proposal from Swedish PE outfit EQT Fund Management via a Scheme of Arrangement at a price range of between A$15.30 and A$15.50 cash per share.

EQT had previously fielded an Offer of A$14.80/share on the 18 June.

Iress’ board unanimously concluded that the Proposal was “conditional and did not represent compelling value for Iress shareholders“. But the board was:

prepared to provide it with access to limited non-public information so EQT can develop a proposal that is capable of being recommended to shareholders.

Iress closed up 15% today, but still 7% below the mid-point of the Indicative Offer price range.

As always, more below the fold.


KRX Autos Rebalancing on September 9: Watch Myoungshin Industrial as a New Add

By Sanghyun Park

Myungshin Industries is running again. Myungshin Industrial is considered a Tesla-related stock because Tesla is a major customer. As Tesla recently announced surprise earnings, the stock price of Myungshin Industrial is also moving up.

In the past five trading days alone, the share price has risen more than 8%. Its current market cap has exceeded 1.7 trillion won.

So this stock appears to offer some opportunities from an index rebalancing trading perspective as well.

The first thing to consider is the inclusion of the KOSPI 200. In the rebalancing of last June, the stock price did not meet the market cap threshold due to the share price being drifted sideways for several months. However, in this December’s rebalancing, if the current share price uptrend continues, the possibility of inclusion seems quite high.

However, we can find trading opportunities in the KRX Autos sector index rebalancing, which takes place ahead of the KOSPI 200 rebalancing in December.

As for KRX Autos, KODEX currently manages an ETF that tracks it, and it has recently been showing good returns, resulting in a large inflow of funds. The AUM now amounts to ₩649.0B, which isn’t bad for an index containing only 17 constituents.

This is a float-adjusted market cap-weighted index with a 20% cap. Rebalancing takes place annually in September. The implementation date is the first trading day of the week following the last trading day for KOSPI 200 futures contracts. So, September 10 will be the implementation date for this year, meaning that we will see rebalancing trading at the close on September 9.

Index summary
Index nameKRX Autos
ETF
Samsung Kodex Autos ETF
Ticker091180
AUM₩649.0B
Price₩23,305
SO27,850,000
Number of constituents17
Weight type
Float-adjusted market cap
Cap20.00%
Rebalancing cycleAnnually
Rebalancing monthSeptember
Announcement date
One week ahead of implementation
Implementation date
The first trading day of the week following the last trading day for KOSPI 200 futures contracts
Next implementation date
September 10, 2021
Rebalancing trading
At the close on September 9, 2021
Screening base date
The last trading day of the month preceding the date of regular rebalancing
Screening period
The three months preceding the screening base date
Source: KRX & KODEX ETF

Before it’s here, it’s on Smartkarma

Most Read: Hansoh Pharmaceutical, PropertyGuru , Krafton Inc, Alibaba Group, Invesco Office J Reit and more

By | Daily Briefs, Most Read

In today’s briefing:

  • As The Dust Settles – Potential Index Changes to the FTSE China 50/A50 & HSCEI
  • PropertyGuru/Bridgetown 2 SPAC Listing/Merger – Second Time Lucky – Some Food for Thought
  • Krafton Bookbuilding: A Quick Recap of Last Day Craziness
  • Few Points to Consider Before Bottom Fishing Chinese Tech
  • Invesco Real Estate Deal for Invesco Office (3298) Successful – Now For the Aftermath

As The Dust Settles – Potential Index Changes to the FTSE China 50/A50 & HSCEI

By Brian Freitas

As regulations have changed in China, and as the market positions for regulations that could be changed in China, the fallout has resulted in markets selling off with a few sectors firmly in the crosshairs.

What started off with the ‘three red lines’ for real estate companies, the pulled IPO of Ant Financial Services Group (6688 HK) in November 2020 and regulating monopolies in big-tech has spread to the online education industry, food delivery industry, property service companies and the market is bracing for regulation of the medical and pharmaceutical industry.

The rampant selling of stocks that are affected by the regulations or could be affected will have an impact on the upcoming September index rebalances for the FTSE China 50 Index and FTSE China A50 Index (XIN9I INDEX) and the December rebalance for the Hang Seng China Enterprises Index (HSCEI INDEX).

In addition, there will be a lot more mainland China companies that will list in Hong Kong since they will not need to (or will find it easier to) get approval from the Cyberspace Administration of China. That will also have implications for these indices.

In this Insight, we look at the potential changes to the FTSE China 50, FTSE China A50 Index (XIN9I INDEX) and Hang Seng China Enterprises Index (HSCEI INDEX) in the upcoming reviews based on the close of trading on 27 July.


PropertyGuru/Bridgetown 2 SPAC Listing/Merger – Second Time Lucky – Some Food for Thought

By Sumeet Singh

PropertyGuru and Bridgetown 2 announced, on 23rd Jul 2021, that they have entered into a business combination agreement which will see PropertyGuru go public in the US. The transaction will value PropertyGuru at an EV of US$1.35bn and equity value of US$1.78bn.

We have looked at the company’s prior listing attempt when it tried to list in Australia in 2019. In this note, we will comment on the current listing arrangement.

Link to our previous notes:


Krafton Bookbuilding: A Quick Recap of Last Day Craziness

By Sanghyun Park

The last day of Krafton’s bookbuilding? Well, it was really a crazy day.

A suspicious rumor circulated at noon yesterday

First of all, at noon yesterday, a rumor circulated among local institutions through the messenger mainly used by institutions.

Previously, Yahoo Messenger was the main medium for circulating all sorts of rumors and stories between local institutional investors. But after the Yahoo Messenger service was terminated, NateOn is mainly used now.

The content of this rumor was somewhat provocative. The rumor said that the bankers are currently holding an emergency meeting due to the low competition rate for institutional subscriptions in the Krafton bookbuilding.

When Mirae Asset Securities learned that this rumor was circulating through NateOn, it immediately denied it, which led to an unusual situation where a banker updated the bookbuilding progress even before bookbuilding was closed.

In fact, Mirae Asset explained to local institutions yesterday afternoon that this Krafton bookbuilding was significantly more positive than initially expected and that the rumor of holding an emergency meeting due to the disastrous results simply was not true.

However, it is said that this rumor has caused confusion among some local institutions and has had some effect on the institutional subscription rate on the last day.


Few Points to Consider Before Bottom Fishing Chinese Tech

By Oshadhi Kumarasiri

After trading sideways during May/June 2021, bulls got excited as Alibaba Group (9988 HK) rallied by 10% in the last week of June to $229.4 per share. Unfortunately, the joy was cut short, as Xi Jinping’s government went back on the offence with a broadened crackdown on tech platforms, especially the US-listed Chinese tech companies like the recent ride-sharing IPO DiDi Chuxing (DIDI US). As a result, Alibaba’s share price dropped 15% to a new 52 week low. Before the dust settled the Chinese government introduced reforms to private education companies, preventing them from making profits from the after-school tutoring businesses.

We believe all of these interventions are messages about the direction of the government policy over the next few years and the government’s effort to bring equality through preventing monopolistic behaviour and address cybersecurity, data collection and privacy concerns could be broader policies of Xi Jinping’s government as the Chinese economy enters a new era of growth.

New economy stocks like Alibaba, Tencent, Vipshop and JD.com have never gone through a period of time that’s even remotely similar to the time frame it is about to go through in the next few years.

Therefore, we think bottom fishing Chinese e-commerce stocks during this regulatory crackdown and economic policy transition could be of high risk unless they get to a point where they are bargains on price to book multiples.

In this insight, we discuss some important points to make a note of, if you are considering bottom fishing Alibaba, one of the safest Chinese tech stocks in the market.


Invesco Real Estate Deal for Invesco Office (3298) Successful – Now For the Aftermath

By Travis Lundy

The bid by the Invesco parent company (Invesco Real Estate and affiliates) for Invesco Office J Reit (3298 JP) turned out successful, and the bidders gained 5,727,676 units out of the 8,802,650 units out in the float. They now own 65.07% (having started with 6%) so this will end up going to an EGM.

As described in the original Notice concerning the Statement of Opinion (Support) on Tender Offer by Invesco Group released by IOR on 17 June and in line with my earlier insights, there will be an EGM which will aim to squeeze out minorities. That would theoretically require a two-thirds vote to change the Articles of Incorporation. 

The key date is 31 October 2021 because that is the end of the current (15th) fiscal period. The buyer should try to get the squeezeout accomplished by the end of that period, and if possible, to push it onward to a new fund on or before that date which can be declared to be distributed so that the tax conduit remains in place. 

The language in the Opinion says… 

Additionally, the Tender Offerors intend to request the Investment Corporation to convene an extraordinary unitholders’ meeting before the end of October 2021, which is the end of the 15th fiscal period of the Investment Corporation (meaning the last day of the fiscal period, hereinafter the same), and amend its articles of incorporation to change the end of the 15th fiscal period from October 31, 2021 to April 30, 2022.

There is separate language which says there will be no more dividends for the period ended 31 October 2021. Investors who hold on to the other 34.93% are now long a thing which will not earn anything in future for them. 

Who still owns units? What does that mean? Is there an arb? Are there index trades? 

The answers to this and more below the fold. 


Before it’s here, it’s on Smartkarma

Most Read: Softbank Group, TAL Education, Tencent, Hansoh Pharmaceutical, Li Auto Inc. and more

By | Daily Briefs, Most Read

In today’s briefing:

  • JAPAN PASSIVE: Who Owns What 2021?
  • TAL Education (TAL): In New Rule on Tutoring School, “Article 13” Harsher Than “Non-Profit”
  • Tencent Holdings – Only The Beginning
  • As The Dust Settles – Potential Index Changes to the FTSE China 50/A50 & HSCEI
  • Li Auto (LI US) Dual Primary Listing: HSCI Fast Entry; HSCEI Dec Inclusion & Div Futures Lower

JAPAN PASSIVE: Who Owns What 2021?

By Travis Lundy

A few years ago I started this series, and I updated it last year. Since last year, it has been a top 10 insight in terms of views. 

I personally think it is important for investors of all types to understand WHO OWNS WHAT. 

Many fundamental investors are reticent to spend any time on this but there are many reasons why active investors in Japan should be interested in understanding the ownership and shareholder dynamics of passive investors in Japan.

Some of the places active investors will see their influence are:

  • Stories intermittently published about the BOJ’s presence in Japanese ETFs (especially the fact that it owns 85+% of the outstanding ETF market),
  • Relatively constant interest in Nikkei 225 rebalances like the one we saw in July 2020, which helped push up Japan Exchange Group (8697 JP) by 30+% from May to July, then helped it slide 13% in a week, or the changes in the Nikkei 225 review rules published earlier this year which may change what happens this September to a few large caps, and the announcement of the BOJ that it would no longer buy Nikkei 225 ETFs which started a long slide in Fast Retailing (9983 JP) shares against comps and the Nikkei itself. Long “held up” by ‘market inventory’ and Nikkei 225 ETF buying, when the BOJ stopped, it removed the cushion and existing inventory holders had to sell out. 
  • Then if you look at the shareholder structure of Fast Retailing today, you will see that it is STILL fundamentally a serious problem for large foreign active investors who would actually wish to take an active (but not activist) position. Real World Float on the stock is, by my calculation, less than 15% of shares outstanding. 
  • The relatively recent policy of increased stewardship regarding the passive management portion of the GPIF (the Government Pension Investment Fund) – an investing heavyweight in Japan.
  • The timing and quantum of after-event support or overhang on corporate actions such as buybacks, secondary offerings, primary offerings, mergers, etc. 
  • Index inclusions mean big flows. If you follow the insights on TOPIX Inclusions by Janaghan Jeyakumar, CFA and myself, you will often see big moves. Sometimes these stocks move 50% between when we write about them and when they go into the index. If you own them and are considering an exit, you need to know when to take profits, and the dynamic of the liquidity. If you are thinking about getting in for fundamental reasons, it pays to know early so you can get ahead of the major flow.
  • The return of Toshiba Corp (6502 JP) to the TSE First Section in Q1 this year changed the foreign shareholder percentage ownership, lowering it by 10%. Smartkarma readers knew this last year and in January, which prepared them for the June AGM when the shareholder category ownership was released.
  • The changes to the TSE’s market structure, which will affect TOPIX membership, which will affect many companies’ issuance, buyback, share cancellation, etc decisions over the next several months. They are doing this because of the TSE Prime listing rules which will effectively also determine whether or not they will be included in TOPIX in future, or whether they will fall out of TSE Prime and will see constant selling over late 2022 to early 2025. 

Of course, TOPIX is just over half of the passive tracking AUM in Japan. There’s more. 

Find out WHO OWNS WHAT in Japan Passive below the fold. 


TAL Education (TAL): In New Rule on Tutoring School, “Article 13” Harsher Than “Non-Profit”

By Ming Lu

  • The new rule for tutoring school damaged the prices of Chinese education equities.
  • The market focuses on the “non-profit” requirement, but we believe “Article 13” is more important.
  • We believe the authorities try to block all the ways that a tutoring school can continue.
  • We do not believe this is a “low-price opportunity” after the stock price plunge.
  • Please also see TAL Education (TAL): Last Summer for Physical Tutoring School on June 28 before the price plunge.

Tencent Holdings – Only The Beginning

By Thomas J. Monaco

*What’s Up With WeChat: Mainland China appears to have taken additional action against Tencent Holdings (700.HK) [Tencent], following Monday’s regulatory edict. Tencent is suspending new user registrations for its WeChat services, as it is undergoing a “security technical upgrade” in accordance with relevant laws and regulations. WeChat is Tencent’s most important business, and dominates mainland Chinese social media; and 

*Pain Trade Coming:Tencent is widely expected pay a large fine. In addition, Tencent may have to give up its exclusive music rights and possibly dispose of Kuwo and Kugou. Further, we have no doubt that Tencent will also follow Alibaba Group (BABA.US) [Alibaba] in their formation of a financial holding company. For Tencent, WeChat Pay and the broader lending/deposit taking business are likely to be reined-in. At CNY 38.5 bn for full year 2020, FinTech represents a growing 28.8% of revenue – and is a key and growing component of Tencent’s current and future results. No matter what spin that Tencent wants to place on its other businesses, an FHC represents significant downside risks. Earnings will compress, as capital requirements increase.


As The Dust Settles – Potential Index Changes to the FTSE China 50/A50 & HSCEI

By Brian Freitas

As regulations have changed in China, and as the market positions for regulations that could be changed in China, the fallout has resulted in markets selling off with a few sectors firmly in the crosshairs.

What started off with the ‘three red lines’ for real estate companies, the pulled IPO of Ant Financial Services Group (6688 HK) in November 2020 and regulating monopolies in big-tech has spread to the online education industry, food delivery industry, property service companies and the market is bracing for regulation of the medical and pharmaceutical industry.

The rampant selling of stocks that are affected by the regulations or could be affected will have an impact on the upcoming September index rebalances for the FTSE China 50 Index and FTSE China A50 Index (XIN9I INDEX) and the December rebalance for the Hang Seng China Enterprises Index (HSCEI INDEX).

In addition, there will be a lot more mainland China companies that will list in Hong Kong since they will not need to (or will find it easier to) get approval from the Cyberspace Administration of China. That will also have implications for these indices.

In this Insight, we look at the potential changes to the FTSE China 50, FTSE China A50 Index (XIN9I INDEX) and Hang Seng China Enterprises Index (HSCEI INDEX) in the upcoming reviews based on the close of trading on 27 July.


Li Auto (LI US) Dual Primary Listing: HSCI Fast Entry; HSCEI Dec Inclusion & Div Futures Lower

By Brian Freitas

Li Auto Inc. (LI US) has got approval from the HKEX (388 HK) for a dual primary listing. Media reports indicate that the company could raise between US$1bn-2bn in the offering. Based on the XPeng (9868 HK) timeline, Li Auto could list around 6-9 August.

Xpeng (XPEV US) / XPeng (9868 HK) raised US$1.8bn via a dual primary listing earlier this month and Li Auto Inc. (LI US) is following closely behind. Maybe NIO Inc (NIO US) comes next.

We expect Li Auto Inc. (LI US) to get Fast Entry to the Hang Seng Composite Index (HSCI) though, as a WVR security, the stock will only be eligible for Stock Connect once it has completed 6 months of listing plus 20 trading days.

Li Auto could also be included in the Hang Seng China Enterprises Index (HSCEI INDEX) at the December review. This will lead to a further drop in the HSCEI 2022 dividend futures since we do not expect Li Auto Inc. (LI US) to pay dividends in the near future, while the potential deletion is a higher dividend yielding stock.


Before it’s here, it’s on Smartkarma

Most Read: TAL Education, Chinasoft International, New Oriental Education, Softbank Group and more

By | Daily Briefs, Most Read

In today’s briefing:

  • China After School Tutoring Online Education Stocks Crushed – Investors Schooled
  • MSCI Aug 2021 Index Rebalance Preview: Potential Changes After Week 1; Positioning at Work
  • China’s New After-School Tutoring Policy Is Out – The End of the Line For Many?
  • China Private Education: How to Position After the Regulatory Crackdown?
  • Softbank Group – China Has Just Blown a Hole in Vision Fund’s Rapid Listing Theme

China After School Tutoring Online Education Stocks Crushed – Investors Schooled

By Travis Lundy

Earlier today, it was reported by the 21st Century Business Herald that China was going to ban IPOs by educational companies and platforms which tutor on subjects in the public school curriculum and ban investments in such companies by those which are already listed. 

Bloomberg reported that China was considering asking companies that offer such tutoring – to help students pass the gaokao – the legendarily difficult college entrance exams – to turn into non-profit businesses. 

The initial story is that online education platforms would not be allowed to raise money in capital markets, sell securities, go public. The bigger picture is that they are effectively being pushed out of business. This particular news has sent education (especially school curriculum tutoring platforms) stocks dramatically lower in Hong Kong trading, and in the US pre-open market.

Drops of 30-50% are par for the course so far.

There is a possibility this kills the entire business for some platforms. 

This comes on the back of a crackdown starting earlier this spring on after-school tutoring platforms after Xi Jinping said in March at the Two Sessions that the practice was a “social problem” affecting kids social and mental health and he urged “resolute rectification.”

Right there, that should have warned everyone this story was not going to have a happy ending. 

This followed a scandal in January where four schools, including Yuanfudao, Zuoyebang, and the education unit all hired the same actress to pose as a teacher in ads for their platform, in at least one video laying the guilt on parents saying if parents didn’t sign up for the streaming courses, it could have consequences, “90% of mothers make mistakes” and “it could be parents themselves who ruin their kids [chances].” In one she was an English teacher with 35 years experience. In another she had been a math teacher all her career. It was not a good look.

The media followed Hi Jinping’s comments with polemics on predatory practices and fear-based advertising, which had gone rampant as the VC investees aimed at growth above all. This put an immediate halt to the preparations many of the mega-tech conglomerates invested in China – Alibaba Group (BABA US), Tencent (700 HK), Softbank Group (9984 JP), and others – had made to list their education-related projects such as Zuoyebang (Alibaba) which raised US$2.35bn in two rounds last year, Yuanfudao (Tencent) which raised US$3.5bn in three rounds, VIPKid (Tencent) which does English teaching, Huohua Siwei (Tencent) which specialises in STEM, and others which were either launching (like ByteDance’s newest effort Dali Education after buying Hua Luogeng math school and renaming it Qingbei Online School, and one-on-one tutoring platform GoGoKid), or preparing themselves to start on the road to IPO or at least looking at a 2022 listing. Zhangmen Education (ZME US) actually IPOed in late May at US$11.51/ADR, rising 50% on Day 1, falling back to US$9.54 yesterday and now down 26% in pre-market. 

Such companies had grown dramatically in 2020 as covid restrictions, or precautions, increased the desire for parents to keep their kids at home. Preqin says VC funding in the sector hit a record $10.5bn in 2020. The market is huge, and growing fast. Online tutoring grew 35-40% last year as covid struck according to iResearch in Shanghai, reaching RMB 257bn. Others have higher numbers. And according to Oliver Wyman and the National Institute of Educational Sciences, the overall market for after-school education was RMB 800bn in 2019, expected to rise to RMB 1.4trln in 2025.

The four major problems that regulators appear to have focussed on this spring after Xi Jinping’s comments were:

  • fast-increasing expense on families, which would restrict the incentive to have more kids and also create a significant separation between the chances for kids with well-to-do parents and kids without. The criticism in the 21 May 19th Meeting of Central Comprehensive Deepening Reform Commission, which released a flurry of Opinions* was that children faced a lower burden in school and a greater burden out of school.

*”Guiding Opinions on Improving the Evaluation Mechanism of Scientific and Technological Achievements”, “Opinions on Further Reducing the Burden of Students’ Homework and Off-campus Training in Compulsory Education”, and several others.

  • marketing free-for-all with false or damaging advertising and predatory plan pricing and structuring, including pre-charging for classes which would not be used. 
  • A lack of regulation/strict oversight of teacher/tutor licensing, ensuring proper resource allocation to teachers themselves, 
  • and a get-rich-quick mindset from what Xi Jinping thinks should be a solemn duty to educate the youth of the country. 

As Xinhua put it in reporting about that May 21 meeting…

会议强调,要全面规范管理校外培训机构,坚持从严治理,对存在不符合资质、管理混乱、借机敛财、虚假宣传、与学校勾连牟利等问题的机构,要严肃查处。要明确培训机构收费标准,加强预收费监管,严禁随意资本化运作,不能让良心的行业变成逐利的产业。要完善相关法律,依法管理校外培训机构。各级党委和政府要强化主体责任,做实做细落实方案,科学组织、务求实效,依法规范教学培训秩序,加强权益保护,确保改革稳妥实施。

The meeting emphasized that it is necessary to fully regulate the management of off-campus training institutions, adhere to strict governance, and severely investigate and deal with institutions that have problems such as non-qualification, chaotic management, taking advantage of money, false propaganda, and collusion with schools for profit. It is necessary to clarify the charging standards of training institutions, strengthen the supervision of pre-charging, and strictly prohibit arbitrary capitalization operations, and do not allow conscientious industries to become profit-seeking industries. It is necessary to improve relevant laws and manage off-campus training institutions in accordance with the law. Party committees and governments at all levels must strengthen their main responsibilities, implement the plan in detail, organize scientifically, seek practical results, standardize the order of teaching and training in accordance with the law, strengthen the protection of rights and interests, and ensure the steady implementation of reforms.

In April, the Beijing Administration for Market Regulation fined New Oriental Online RMB 500,000 for pricing violations, and false advertising. Koolearn (1797 HK), TAL Education (TAL US), were also hit.  Shifara Samsudeen, ACMA, CGMA wrote about this in GSX TechEdu: China Fines Online Tutoring Apps for Making Misleading Claims; Is GSX Next? in early May.

In late May, China decided kindergartens and private tutoring schools could no longer teach the elementary school curriculum, starting June 1, as part of a revision of the Minority Protection Law. Gaotu Techedu (GOTU US) immediately announced it was shutting down its Xiao Zao Qi Meng pre-school education business (3-8yrs). On June 1, the government fined another 15 operators a total of RMB 36.5mm for similar violations to New Oriental Online, including pre-IPO unicorns Zuoyebang and Yuanfudao, with both getting hit for RMB 2.5mm which is the maximum legal amount. New Oriental got hit again. TAL, Onesmart Education (ONE US), China BestStudy (3978 HK) and Bright Scholar Education (BEDU US) were also hit for the same reasons by SAMR. And then another 10 were hit by local regulators in Guangdong and Shanghai. It was a coordinated attack on Children’s Day.

In the first week of June, Xi Jinping made a much-touted visit to Qinghai in the southwest and it appears both he and the media talked quite a bit about lifting up the lower income areas and people, as per the 14th Five Year Plan, and also noted the problem of after school tutoring burdening students more and school burdening students less, calling it “putting the cart before the horse.”

The Ministry of Education set up a new department (the Off-Campus Education and Training Department) on 15 June to regulate the off-campus tutoring schools to “reduce students’ academic burden”, etc. It will oversee teachers and curricula. Smartkarma provider Zhen Zhou, Toh wrote about the prospects for companies going forward in late June in China Online Education – Diversified Revenue Stream Wins Here – Balance in All Things

Three weeks ago, the Beijing Municipal Education Commission and at least a half dozen other major cities across the country set up summer after-school programs for elementary school students, effectively taking the business which would normally be taken by private sector schools.

The writing has been on the wall since March. And the authorities have been writing over it in heavier and heavier marker for weeks and months.

The largest businesses out there have been under the cosh, racing against time and competitors with somewhat dodgy numbers and promises. They lose money, and now it looks like they won’t be able to raise more. 

A number of Smartkarma insight providers have published insights which have discussed the opportunities and the red flags in the sector. This includes short reports, pre-IPO reports, updates on legal and regulatory changes, and a huge report on the private education sector by Osbert Tang, CFA a few months ago, called China Private Education: This Is Where the Future Lies which has an enormous amount of detail about the sector.

Issues With the Business

The major issues for regulators appear to be…

  • criticisms of false advertising, where the benefits to such education are promised but not proven, where there are spurious claims using fake claims. 
  • criticisms of the structure of the offerings. A number of courses are offered at RMB 1 for the whole course, but then they come back to charge you for extras later. 
  • the “burden” placed on children
  • an air of get rich quick to the entire industry which is seen to be against the national interest.

For investors, many of the major issues have to do with how companies which promise growth are actually “growing.”

Gaotu, formerly called GSX Techedu, had claimed to be the leading provider of online classes from K-12, was IPOed in 2019 at a $3bn valuation, rose to 10x that, then fell. GSX had been the subject of short seller reports in the first half of 2020 accusing the company of inflating student enrolment numbers using bots, fabricating teachers, falsifying reviews, and falsifying revenues. Multiple reports (as per GMT Research’s Hall of Shame on GSX, Grizzly Research, Muddy Waters, JLWarren who wrote 30 May on Smartkarma in GSX: Minimal Market Share; ~80% Fake Enrollment and Operational Irregularities, GMT itself, and others (links at the bottom of that link) found different former teachers or others who talked about faked reviews, faked parents, faked students, bots/brushing, related party transactions to create expenses, or remove them (depending on the short seller report), boosted to remove the cash that should have been there from the fake revenue, possible fake capital raise, etc. The laundry list of accusations is long, sordid, and painfully similar to situations which have later been determined to be fraud. 

Against the pattern of companies calling out short seller research firms’ reports, GSX was often curiously quiet, and the stock rose anyway, tripling after Muddy Waters released their report from $40/share to $120/share before falling back.

The shares then rallied very sharply in January as part of a short squeeze on “meme stonks” and heavily-shorted names. Archegos apparently owned more than 10% through a variety of PB accounts. Archegos fell. GSX fell with it. And since then it has lost another two thirds of its value to get back to under US$10/share. 

Pre-market, it is apparently indicated at US$3.65/share. Down 62%. 

A Side Problem

Evelyn Zhang recently wrote about the change in attitude towards “white collar education” in A Twist of Fate – China’s Suppression of Secondary Education in Favor of Vocational Education. It is a good read. 

Her advice on 3 July was to short all Chinese online education stocks which had a K-12 offering, and go long all companies which provided vocational training.

After today, that will have been a beauty of a trade. 

Medium-term, the problem authorities will find is that parents don’t necessarily want their kids to not have access to the after-school cram services. They don’t have time to teach them themselves, and because the cutoff to continue later education is harsh and many parents don’t want their kids to go to vocational school to enter the blue collar workforce, lots of parents are actually objecting to the crackdown. They are happy to pay if it gives their kids a better chance. 

The high cost of education is one reason to not have a second (or third) child. The high cost of real estate is another. But education is status and a chance at wealth and intellectual happiness. It has been the case for hundreds of years in China. It is not clear that if the public sector takes on the education and after-school education “burden” from the private sector that it will please the wider public. It is not clear an increased number of qualified teachers will want to get paid public education system wages either. 

The Problem For Investors

Now the chickens are coming home to roost. 

Xi Jinping declared after-school education to be a “social problem” in front of the Two Sessions. Some people did not take him seriously at the time, but regulators have been taking his words seriously and have started cracking down. Legislators have made new legislation. And the Ministry of Education has a new department. 

Now it appears China wants foreign capital out of the business, and it wants those operators (already listed, or unicorns sponsored by China megatech) which have raised capital to not use it grow market share. 

It wants the entire business to support the national interest. Without profit. 

Larry Chen (founder and chairman of Gaotu), once a teacher in an impoverished little village, later become multi-billionaire, may not be able to keep his billions. And I expect this does not bother Xi Jinping.

A basket of names in HK, mainland China, and NYSE (using pre-market prices as of one minute before the open for today’s price) is shown below. It is a heavy hit.

By my count using pre-open prices and the ugly HK closes, that is $18bn in one shot on those 16 names.

More below the fold.


MSCI Aug 2021 Index Rebalance Preview: Potential Changes After Week 1; Positioning at Work

By Brian Freitas

MSCI is scheduled to announce the results of the August 2021 Quarterly Index Review (QIR) on 11 August (early morning of 12 August Asia time) with the changes implemented after the close of trading on 31 August.

The review period for price cut-off began on 19 July and will run through to 30 July. After the end of week 1 of the review period, most of the changes are expected in China with a few changes for Hong Kong, Taiwan, Korea and Thailand.

Most of the names appear on the add/delete list every day during the review period, while a few names appear/drop out of the list of potential changes. The final list will depend on the day that MSCI chooses. Based on historical data, there is over a 90% probability that MSCI chooses a day from week 1 to compute the market cap for the stocks that will determine the list of inclusions and exclusions.

Post week1 of the review period, potential inclusions to the MSCI Standard Index are SITC International (1308 HK)Huabao International Holdings (336 HK)Momo.Com Inc (8454 TT)Chinasoft International (354 HK)China United Network A (600050 CH)Ecopro BM Co Ltd (247540 KS), SK IE Technology (361610 KS), CRRC Corp Ltd A (601766 CH)Beijing Wantai Biological-A (603392 CH)Beijing Kingsoft Office Software-A (688111 CH)Beijing Roborock Technology-A (688169 CH)Imeik Technology Development (300896 CH)StarPower Semiconductor Ltd (603290 CH)Advanced Micro-Fabrication Equipment-A (688012 CH), Ginlong Technologies Co Ltd (300763 CH) and China Baoan (000009 CH).

Potential exclusions are Bangkok Bank PCL (BBL/F TB), Bank of East Asia (23 HK), Taiwan Business Bank (2834 TT), KMW Co Ltd (032500 KS), Perennial Energy Holdings Ltd (2798 HK), Douyu International Holdings (DOYU US) and Gaotu Techedu (GOTU US).

The August QIR will also implement tranche 2 of Sea Ltd (SE US)‘s inclusion in the MSCI indices and will result in the index inclusion factor increasing from 0.05 to 0.25.

There is also a very high probability of a 75% reduction in the  SK Telecom (017670 KS)‘s Foreign Inclusion Factor (FIF) due to a drop in the availability of foreign room on the stock.


China’s New After-School Tutoring Policy Is Out – The End of the Line For Many?

By Travis Lundy

On Friday 23 July, the 21st Century Business Herald and Bloomberg followed up one stories which had come out a couple of days earlier (which suggested much more regulation on after-school tutoring businesses), suggesting that China would possibly ban for-profit businesses which tutored China’s K-12 students on school curriculum subjects. The same articles Friday suggested no listed businesses would be able to purchase or invest in such businesses, and foreign capital would not be allowed to invest in the businesses.

This was discussed pre-US open in China After School Tutoring Online Education Stocks Crushed – Investors Schooled. This seemed dramatic, and possibly dire. Stocks in the K-12 education sector in Hong Kong fell dramatically. Stocks listed in the US fell even more. A custom index of 16 names fell nearly 30%. An index of just the three major US-listed names – TAL Education (TAL US), Gaotu Techedu (GOTU US), and New Oriental Education (EDU US) – was down 60% pre-open.

That wasn’t enough as the basket closed 6% lower from there. 

It looks like even that may not have been enough.

The NEW News

On Saturday, the State Council followed up with a document“Opinions on Further Reducing the Workload of Students and The Burden of Out-of-School Training in the Compulsory Education Stage”

The Opinion is a wide-ranging polemic with instructions to local governments, school systems, educational authorities, etc to deal with the reduction of “double burden” on kids and parents of school system and after-school tutoring system on the same subjects as taught in the school system. There is lots of content suggesting significant detail on things like homework in regular school, who is to be given how much, how much they are not to do, what school administrators in the public school system should do to organise after-school and summer programs. 

There are, of course, the sections about the after-school tutoring businesses – strictly enforcing regulations, ensuring proper qualifications, and severely punishing those institutions which fall short, especially those with a profit incentive. 

If I were in that business, I would stop making a profit immediately. I would refund payments for currently in-progress classes so that the only payments related to teacher payments and bare minimum support costs are done. I would provide refunds to anyone who would take them so as to immediately cease the business. 

Some businesses may be able to pivot. Some may be liquidation candidates. Some will simply be shut down to take the loss. 

But this is a big change, and it has been out there. And it looks like when people did not see it quickly enough, it was decided Something Must Be Done. Now it is going to be done.


China Private Education: How to Position After the Regulatory Crackdown?

By Osbert Tang, CFA

Share price of the China Education Sector stocks, particularly the US listed online education ones, are hit hardest on Friday amid the rumoured release of extremely stringent government regulatory changes. The CCPC and State Council official announcement was made on Saturday, and basically removed the survival of online and curriculum-related after-school tutoring classes for Pre-K and compulsory education grades. New Oriental Education (EDU US), TAL Education (TAL US) and Gaotu Techedu (GOTU US) all pledged to support the decisions on Saturday night via Weibo.

We believe the best way to position in the sector is to focus on higher and vocational education sub-segments. In this regard, China Education Group (839 HK) is best positioned given its pure exposure in this market and nil exposure to K-12 schools (online/offline). The 26.3% drop in share price from the peak provides an attractive entry point, in our view. Among the three online education companies, New Oriental Education (EDU US) looks comparatively safer due to its buffer from other businesses, but we would warn against the extreme risks associated with bottom-fishing this name.


Softbank Group – China Has Just Blown a Hole in Vision Fund’s Rapid Listing Theme

By Kirk Boodry

Softbank has been touting Vision Fund’s IPO flywheel for almost all of 2021 but expect that to fade as the reality of China’s crackdown sinks in. It’s stake in Didi is worth $8bn as of Friday down from $10.6bn invested at the parent and $12bn total whilst other recent IPOs (YMM -28% on 23 July, ZME -35%, DDL -8%) are also under pressure. The good news is Vision Fund China assets are <10% of total China exposure and Alibaba has been through the regulatory wringer already. That limits China downside but it does call into question Vision Fund hopes for valuation gains from liquidity events. There is a direct read across with Zuoyebang and VIPThink which are banned from going public whilst three of the largest private investments remaining in Vision Fund 1 (Bytedance, ele.me and Guazi) are likely to remain on the sidelines. We expect the holding company discount is likely to remain in the 44% range.


Before it’s here, it’s on Smartkarma

Most Read: TAL Education, Chinasoft International, Kuaishou Technology, SK Telecom, Zomato and more

By | Daily Briefs, Most Read

In today’s briefing:

  • China After School Tutoring Online Education Stocks Crushed – Investors Schooled
  • MSCI Aug 2021 Index Rebalance Preview: Potential Changes After Week 1; Positioning at Work
  • Kuaishou Lock-Up Expiry – Getting Close to IPO Price, with US$18bn+ Lock-Up. CCASS Movement as Well.
  • Index Rebalance & ETF Flow Recap: Capitaland, Boral, Xpeng, SK Tel, MSCI, KRX BBIG
  • ECM Weekly (25th July 2021) – China Tourism, APM Monaco, Paytm, CTOS, Zomato, Kuaishou Lock-Up

China After School Tutoring Online Education Stocks Crushed – Investors Schooled

By Travis Lundy

Earlier today, it was reported by the 21st Century Business Herald that China was going to ban IPOs by educational companies and platforms which tutor on subjects in the public school curriculum and ban investments in such companies by those which are already listed. 

Bloomberg reported that China was considering asking companies that offer such tutoring – to help students pass the gaokao – the legendarily difficult college entrance exams – to turn into non-profit businesses. 

The initial story is that online education platforms would not be allowed to raise money in capital markets, sell securities, go public. The bigger picture is that they are effectively being pushed out of business. This particular news has sent education (especially school curriculum tutoring platforms) stocks dramatically lower in Hong Kong trading, and in the US pre-open market.

Drops of 30-50% are par for the course so far.

There is a possibility this kills the entire business for some platforms. 

This comes on the back of a crackdown starting earlier this spring on after-school tutoring platforms after Xi Jinping said in March at the Two Sessions that the practice was a “social problem” affecting kids social and mental health and he urged “resolute rectification.”

Right there, that should have warned everyone this story was not going to have a happy ending. 

This followed a scandal in January where four schools, including Yuanfudao, Zuoyebang, and the education unit all hired the same actress to pose as a teacher in ads for their platform, in at least one video laying the guilt on parents saying if parents didn’t sign up for the streaming courses, it could have consequences, “90% of mothers make mistakes” and “it could be parents themselves who ruin their kids [chances].” In one she was an English teacher with 35 years experience. In another she had been a math teacher all her career. It was not a good look.

The media followed Hi Jinping’s comments with polemics on predatory practices and fear-based advertising, which had gone rampant as the VC investees aimed at growth above all. This put an immediate halt to the preparations many of the mega-tech conglomerates invested in China – Alibaba Group (BABA US), Tencent (700 HK), Softbank Group (9984 JP), and others – had made to list their education-related projects such as Zuoyebang (Alibaba) which raised US$2.35bn in two rounds last year, Yuanfudao (Tencent) which raised US$3.5bn in three rounds, VIPKid (Tencent) which does English teaching, Huohua Siwei (Tencent) which specialises in STEM, and others which were either launching (like ByteDance’s newest effort Dali Education after buying Hua Luogeng math school and renaming it Qingbei Online School, and one-on-one tutoring platform GoGoKid), or preparing themselves to start on the road to IPO or at least looking at a 2022 listing. Zhangmen Education (ZME US) actually IPOed in late May at US$11.51/ADR, rising 50% on Day 1, falling back to US$9.54 yesterday and now down 26% in pre-market. 

Such companies had grown dramatically in 2020 as covid restrictions, or precautions, increased the desire for parents to keep their kids at home. Preqin says VC funding in the sector hit a record $10.5bn in 2020. The market is huge, and growing fast. Online tutoring grew 35-40% last year as covid struck according to iResearch in Shanghai, reaching RMB 257bn. Others have higher numbers. And according to Oliver Wyman and the National Institute of Educational Sciences, the overall market for after-school education was RMB 800bn in 2019, expected to rise to RMB 1.4trln in 2025.

The four major problems that regulators appear to have focussed on this spring after Xi Jinping’s comments were:

  • fast-increasing expense on families, which would restrict the incentive to have more kids and also create a significant separation between the chances for kids with well-to-do parents and kids without. The criticism in the 21 May 19th Meeting of Central Comprehensive Deepening Reform Commission, which released a flurry of Opinions* was that children faced a lower burden in school and a greater burden out of school.

*”Guiding Opinions on Improving the Evaluation Mechanism of Scientific and Technological Achievements”, “Opinions on Further Reducing the Burden of Students’ Homework and Off-campus Training in Compulsory Education”, and several others.

  • marketing free-for-all with false or damaging advertising and predatory plan pricing and structuring, including pre-charging for classes which would not be used. 
  • A lack of regulation/strict oversight of teacher/tutor licensing, ensuring proper resource allocation to teachers themselves, 
  • and a get-rich-quick mindset from what Xi Jinping thinks should be a solemn duty to educate the youth of the country. 

As Xinhua put it in reporting about that May 21 meeting…

会议强调,要全面规范管理校外培训机构,坚持从严治理,对存在不符合资质、管理混乱、借机敛财、虚假宣传、与学校勾连牟利等问题的机构,要严肃查处。要明确培训机构收费标准,加强预收费监管,严禁随意资本化运作,不能让良心的行业变成逐利的产业。要完善相关法律,依法管理校外培训机构。各级党委和政府要强化主体责任,做实做细落实方案,科学组织、务求实效,依法规范教学培训秩序,加强权益保护,确保改革稳妥实施。

The meeting emphasized that it is necessary to fully regulate the management of off-campus training institutions, adhere to strict governance, and severely investigate and deal with institutions that have problems such as non-qualification, chaotic management, taking advantage of money, false propaganda, and collusion with schools for profit. It is necessary to clarify the charging standards of training institutions, strengthen the supervision of pre-charging, and strictly prohibit arbitrary capitalization operations, and do not allow conscientious industries to become profit-seeking industries. It is necessary to improve relevant laws and manage off-campus training institutions in accordance with the law. Party committees and governments at all levels must strengthen their main responsibilities, implement the plan in detail, organize scientifically, seek practical results, standardize the order of teaching and training in accordance with the law, strengthen the protection of rights and interests, and ensure the steady implementation of reforms.

In April, the Beijing Administration for Market Regulation fined New Oriental Online RMB 500,000 for pricing violations, and false advertising. Koolearn (1797 HK), TAL Education (TAL US), were also hit.  Shifara Samsudeen, ACMA, CGMA wrote about this in GSX TechEdu: China Fines Online Tutoring Apps for Making Misleading Claims; Is GSX Next? in early May.

In late May, China decided kindergartens and private tutoring schools could no longer teach the elementary school curriculum, starting June 1, as part of a revision of the Minority Protection Law. Gaotu Techedu (GOTU US) immediately announced it was shutting down its Xiao Zao Qi Meng pre-school education business (3-8yrs). On June 1, the government fined another 15 operators a total of RMB 36.5mm for similar violations to New Oriental Online, including pre-IPO unicorns Zuoyebang and Yuanfudao, with both getting hit for RMB 2.5mm which is the maximum legal amount. New Oriental got hit again. TAL, Onesmart Education (ONE US), China BestStudy (3978 HK) and Bright Scholar Education (BEDU US) were also hit for the same reasons by SAMR. And then another 10 were hit by local regulators in Guangdong and Shanghai. It was a coordinated attack on Children’s Day.

In the first week of June, Xi Jinping made a much-touted visit to Qinghai in the southwest and it appears both he and the media talked quite a bit about lifting up the lower income areas and people, as per the 14th Five Year Plan, and also noted the problem of after school tutoring burdening students more and school burdening students less, calling it “putting the cart before the horse.”

The Ministry of Education set up a new department (the Off-Campus Education and Training Department) on 15 June to regulate the off-campus tutoring schools to “reduce students’ academic burden”, etc. It will oversee teachers and curricula. Smartkarma provider Zhen Zhou, Toh wrote about the prospects for companies going forward in late June in China Online Education – Diversified Revenue Stream Wins Here – Balance in All Things

Three weeks ago, the Beijing Municipal Education Commission and at least a half dozen other major cities across the country set up summer after-school programs for elementary school students, effectively taking the business which would normally be taken by private sector schools.

The writing has been on the wall since March. And the authorities have been writing over it in heavier and heavier marker for weeks and months.

The largest businesses out there have been under the cosh, racing against time and competitors with somewhat dodgy numbers and promises. They lose money, and now it looks like they won’t be able to raise more. 

A number of Smartkarma insight providers have published insights which have discussed the opportunities and the red flags in the sector. This includes short reports, pre-IPO reports, updates on legal and regulatory changes, and a huge report on the private education sector by Osbert Tang, CFA a few months ago, called China Private Education: This Is Where the Future Lies which has an enormous amount of detail about the sector.

Issues With the Business

The major issues for regulators appear to be…

  • criticisms of false advertising, where the benefits to such education are promised but not proven, where there are spurious claims using fake claims. 
  • criticisms of the structure of the offerings. A number of courses are offered at RMB 1 for the whole course, but then they come back to charge you for extras later. 
  • the “burden” placed on children
  • an air of get rich quick to the entire industry which is seen to be against the national interest.

For investors, many of the major issues have to do with how companies which promise growth are actually “growing.”

Gaotu, formerly called GSX Techedu, had claimed to be the leading provider of online classes from K-12, was IPOed in 2019 at a $3bn valuation, rose to 10x that, then fell. GSX had been the subject of short seller reports in the first half of 2020 accusing the company of inflating student enrolment numbers using bots, fabricating teachers, falsifying reviews, and falsifying revenues. Multiple reports (as per GMT Research’s Hall of Shame on GSX, Grizzly Research, Muddy Waters, JLWarren who wrote 30 May on Smartkarma in GSX: Minimal Market Share; ~80% Fake Enrollment and Operational Irregularities, GMT itself, and others (links at the bottom of that link) found different former teachers or others who talked about faked reviews, faked parents, faked students, bots/brushing, related party transactions to create expenses, or remove them (depending on the short seller report), boosted to remove the cash that should have been there from the fake revenue, possible fake capital raise, etc. The laundry list of accusations is long, sordid, and painfully similar to situations which have later been determined to be fraud. 

Against the pattern of companies calling out short seller research firms’ reports, GSX was often curiously quiet, and the stock rose anyway, tripling after Muddy Waters released their report from $40/share to $120/share before falling back.

The shares then rallied very sharply in January as part of a short squeeze on “meme stonks” and heavily-shorted names. Archegos apparently owned more than 10% through a variety of PB accounts. Archegos fell. GSX fell with it. And since then it has lost another two thirds of its value to get back to under US$10/share. 

Pre-market, it is apparently indicated at US$3.65/share. Down 62%. 

A Side Problem

Evelyn Zhang recently wrote about the change in attitude towards “white collar education” in A Twist of Fate – China’s Suppression of Secondary Education in Favor of Vocational Education. It is a good read. 

Her advice on 3 July was to short all Chinese online education stocks which had a K-12 offering, and go long all companies which provided vocational training.

After today, that will have been a beauty of a trade. 

Medium-term, the problem authorities will find is that parents don’t necessarily want their kids to not have access to the after-school cram services. They don’t have time to teach them themselves, and because the cutoff to continue later education is harsh and many parents don’t want their kids to go to vocational school to enter the blue collar workforce, lots of parents are actually objecting to the crackdown. They are happy to pay if it gives their kids a better chance. 

The high cost of education is one reason to not have a second (or third) child. The high cost of real estate is another. But education is status and a chance at wealth and intellectual happiness. It has been the case for hundreds of years in China. It is not clear that if the public sector takes on the education and after-school education “burden” from the private sector that it will please the wider public. It is not clear an increased number of qualified teachers will want to get paid public education system wages either. 

The Problem For Investors

Now the chickens are coming home to roost. 

Xi Jinping declared after-school education to be a “social problem” in front of the Two Sessions. Some people did not take him seriously at the time, but regulators have been taking his words seriously and have started cracking down. Legislators have made new legislation. And the Ministry of Education has a new department. 

Now it appears China wants foreign capital out of the business, and it wants those operators (already listed, or unicorns sponsored by China megatech) which have raised capital to not use it grow market share. 

It wants the entire business to support the national interest. Without profit. 

Larry Chen (founder and chairman of Gaotu), once a teacher in an impoverished little village, later become multi-billionaire, may not be able to keep his billions. And I expect this does not bother Xi Jinping.

A basket of names in HK, mainland China, and NYSE (using pre-market prices as of one minute before the open for today’s price) is shown below. It is a heavy hit.

By my count using pre-open prices and the ugly HK closes, that is $18bn in one shot on those 16 names.

More below the fold.


MSCI Aug 2021 Index Rebalance Preview: Potential Changes After Week 1; Positioning at Work

By Brian Freitas

MSCI is scheduled to announce the results of the August 2021 Quarterly Index Review (QIR) on 11 August (early morning of 12 August Asia time) with the changes implemented after the close of trading on 31 August.

The review period for price cut-off began on 19 July and will run through to 30 July. After the end of week 1 of the review period, most of the changes are expected in China with a few changes for Hong Kong, Taiwan, Korea and Thailand.

Most of the names appear on the add/delete list every day during the review period, while a few names appear/drop out of the list of potential changes. The final list will depend on the day that MSCI chooses. Based on historical data, there is over a 90% probability that MSCI chooses a day from week 1 to compute the market cap for the stocks that will determine the list of inclusions and exclusions.

Post week1 of the review period, potential inclusions to the MSCI Standard Index are SITC International (1308 HK)Huabao International Holdings (336 HK)Momo.Com Inc (8454 TT)Chinasoft International (354 HK)China United Network A (600050 CH)Ecopro BM Co Ltd (247540 KS), SK IE Technology (361610 KS), CRRC Corp Ltd A (601766 CH)Beijing Wantai Biological-A (603392 CH)Beijing Kingsoft Office Software-A (688111 CH)Beijing Roborock Technology-A (688169 CH)Imeik Technology Development (300896 CH)StarPower Semiconductor Ltd (603290 CH)Advanced Micro-Fabrication Equipment-A (688012 CH), Ginlong Technologies Co Ltd (300763 CH) and China Baoan (000009 CH).

Potential exclusions are Bangkok Bank PCL (BBL/F TB), Bank of East Asia (23 HK), Taiwan Business Bank (2834 TT), KMW Co Ltd (032500 KS), Perennial Energy Holdings Ltd (2798 HK), Douyu International Holdings (DOYU US) and Gaotu Techedu (GOTU US).

The August QIR will also implement tranche 2 of Sea Ltd (SE US)‘s inclusion in the MSCI indices and will result in the index inclusion factor increasing from 0.05 to 0.25.

There is also a very high probability of a 75% reduction in the  SK Telecom (017670 KS)‘s Foreign Inclusion Factor (FIF) due to a drop in the availability of foreign room on the stock.


Kuaishou Lock-Up Expiry – Getting Close to IPO Price, with US$18bn+ Lock-Up. CCASS Movement as Well.

By Sumeet Singh


Index Rebalance & ETF Flow Recap: Capitaland, Boral, Xpeng, SK Tel, MSCI, KRX BBIG

By Brian Freitas

In this weeks recap, we look at:

Redemptions continue from the ChinaAMC Semiconductor Chips Index ETF (159995 CH) and there have also been large redemptions from the Samsung Kodex Secondary Battery ETF (305720 KS).

Events This Week

Click on the link under Detail to go to the Insight


ECM Weekly (25th July 2021) – China Tourism, APM Monaco, Paytm, CTOS, Zomato, Kuaishou Lock-Up

By Zhen Zhou, Toh

Aequitas Research puts out a weekly update on the deals that have been covered by the team recently along with updates for upcoming IPOs.

Tencent Music was the latest victim of China’s regulatory crackdown. The company was fined and had to relinquish its exclusive music licensing rights with global record labels in the next 30 days. Daojia also announced that it would halt its US$300m US IPO following similar announcements by Lalamove, Xiaohongshu, and others. 

China ADRs took another leg down on Friday led by education companies falling by more than 50%. This was due to policies that will seek to ban companies that teach the school curriculum from raising capital, going public, and converting them into non-profit entities. Needless to say, China ADR market will take a back seat for a while.

Hong Kong IPO activity remains subdued and we are taking this time to cover upcoming IPOs. This week, we initiated on China Tourism Group Duty Free Corp Ltd. and its secondary listing of up to US$10bn. The firm is the largest travel retail operator in the world and is currently listed in Shanghai. 

We also covered APM Monaco’s US$300m IPO. The company is a contemporary fashion jewelry brand that is popular in China. It designs, manufactures and sells fashion jewelry products such as earrings, necklaces, rings, and bracelets.

We continued our coverage on Transcenta and Shanghai HeartCare which are looking to raise US$200m and US$100m, respectively.

In India, Zomato’s strong debut on Friday should help pave the way for other upcoming large IPOs like PayTM’s which we covered this week. The company boasts an impressive list of pre-IPO investors such as Ant Financial, Softbank and Berkshire Hathaway. The deal will be a combination of both primary and secondary shares. 

We continued our coverage on Yum Brand’s largest franchisor in India, Devyani International, comparing it to other listed competitors. The IPO was approved by SEBI last week.

In Korea, we initiated on Lotte Rental’s US$740m IPO. The company was the largest car rental provider in South Korea. Bookbuild will run between 3-4 August, and shares are expected to list on 19 August. 

Kakao Bank, South Korea’s largest digital bank, priced its books at the top end of the IPO price range. It was reported that its institutional tranche was about 1,700x covered. Shares will debut on 6 August and we have covered the deal earlier.

In Malaysia, Creador-backed CTOS Digital debuted on Monday and closed 47.2% above deal price. Share price has been tapered off from its first day high but still held up well, closing 39% above IPO price on Friday. 

For lock-up expiry, we circled back to Kuaishou which was listed on 5th Feb 2021. Lock-up will expire on 5th August and there had been large CCASS movement that saw JPM holding 638m shares, worth about US$10bn.

On placements this week, Wuxi Biologics Holdings raised US$1.3bn from selling 1.8% of its stake in Wuxi Biologics. The deal had been widely anticipated since this was not its first selldown. Shares were priced at a 6.5% discount but share price struggled to stay above deal price, closing just 0.5% above deal price. 

In Australia, Evolution Mining raised US$294m to acquire assets from its rival, Northern Star Resources. Strong interests came from existing shareholders and new investors. Shares closed 10.4% above deal price on Friday.

In Korea, TongYang Life Insurance raised around US$261m from selling its 3.7% stake in Woori Financial Group. This was a clean-up trade but we think that KDIC could come to market to sell as well. The deal was priced at a 4.29% discount and has traded flat, closing just 0.4% above deal price on Friday. 

Accuracy Rate:

Our overall accuracy rate is 73.8% for IPOs and 67.4% for Placements 

(Performance measurement criteria is explained at the end of the note)

New IPO filings this week

  • Adlai Nortye Ltd. (Hong Kong, >US$100m)
  • Huayuan Medical Group Holding (Hong Kong, >US$100m)
  • Star Health and Allied Insurance Company (India, US$1bn)
  • Anand Rathi Wealth Limited (India, US$135m)

News on Upcoming IPOs

Hong Kong/China

US/China ADRs

India

Others

Analysis on Upcoming IPOs

NameInsight
Hong Kong
Anjuke

Anjuke Pre-IPO – Mixed (Positive and Negative) Developments 

Betta Pharma

Betta Pharma (贝达医药) A+H: Tier 2 Player Struggled to Break Out 

Broncus

Broncus (堃博医疗) Pre-IPO: Big Potential to Be Tested 

ByteDance

ByteDance (字节跳动) IPO: How Jinri Toutiao Paves The Way for a Bigger Empire (Part 1)

ByteDance

ByteDance (字节跳动) Pre-IPO: Why Facebook Should Worry About TikTok 

ByteDance

ByteDance (字节跳动) IPO: Tiktok the No.1 Short Video App for a Good Reason (Part 2)

ByteDance

ByteDance (字节跳动) Pre-IPO: How Has It Done in 1H? 

ByteDance

ByteDance: The Unlisted Company’s Video Apps Leading the Market and Threatening Internet Giants 

ByteDance

ByteDance (字节跳动) Pre-IPO: Why Facebook Should Worry About TikTok 

ByteDance

ByteDance (字节跳动) Pre-IPO – Globally the Most Downloaded App for Jan 2020 Driven by India 

ByteDance

ByteDance (字节跳动) Pre-IPO: Global Ambition Meets Regulatory Challenges 

Dida

Dida Pre-IPO – Making Hay While Big Brother Retreats 

Dida

Dida Pre-IPO – Earnings Forecast and First Stab at Valuation 

Dida

Dida Pre-IPO – Peer Comparison – Lagging in Scale, Leading in Profitability 

Edding Grp

Edding Group (亿腾医药) Pre-IPO: Notes from Latest Financials and Its Related Party 

Edding Grp

Edding Group (亿腾医药) Pre-IPO: Notes from Latest Financials and Its Related Party 

Hanyu

Shanghai Hanyu (捍宇医疗) Pre-IPO: Not a Straight-A but Listing at Right Time 

Intco Med

Intco Medical (英科医疗) A+H: From China No.1 to Global No. 1 

Kilcoy

Kilcoy Global Foods Pre-IPO – Rapid Earnings Growth on the Back of Margin Improvement 

Kilcoy

Kilcoy Global Foods Pre-IPO – A Lot of Things Still Remain Unexplained 

Novotech

Novotech Pre-IPO: Biotech Focused CRO at Hefty Pre-IPO Valuation 

RemeGen RemeGen (荣昌生物) Pre-IPO: Thoughts on Valuation of RC18 and RC48 
SH Bio-heart Shanghai Bio-Heart (上海百心安) Pre-IPO: Needs a Long Runway 
Toplist Toplist China Pre-IPO – Overwhelmingly More Negatives than Positives 
Tasly Tasly Biopharm (天士力生物) IPO: Visible Growth from Approved Drug but Lacks Blockbusters 
WeDoctor WeDoctor (微医) Pre-IPO -App Walk Through – The Online Medical Directory and More 
WeDoctor WeDoctor (微医) Pre-IPO – A More Focused Online Medical Svc Provider than Ping An Good Doctor 
WeDoctor We Doctor (微医) Pre-IPO – Peer Comparison – Picking Its Battles Wisely 
WeDoctor We Doctor (微医) Pre-IPO – Forecasts, Early Thoughts on Valuation, and Acquisition Gripes 
Weilong Weilong Delicious Global Pre-IPO – The Positives – Fast Growth, Strong Backers 
Weilong Weilong Delicious Global Pre-IPO – The Negatives – Spicy Valuation 
WM Tech WM Tech Pre-IPO – Digitalization Efforts Coming Through but Not Well Substantiated 
WM Tech WM Tech Pre-IPO – Peer Comparison and Pre-IPO Valuation – Some Signs of Advantage 
India
Aadhar Housing Aadhar Housing Finance Pre-IPO – Decent past Growth but Comes with Weird Disclosures 
ASK ASK Investment Managers Pre-IPO – Riding on a Wave of Wealth 
Anmol IndAnmol Industries Pre-IPO Quick Take – No Growth, Generous Payments to Founders
Bharat Hotel

Bharat Hotels Pre-IPO – Catching up with Peers 

Bajaj En

Bajaj Energy Pre-IPO – Supposed to Deliver Steady Performance if Only Its Sole Client Would Let It 

CMS InfoCMS Info Systems Pre-IPO – When a PE Sells to Another PE… Only One Gets the Timing Right
Crystal CropCrystal Crop Protection Pre-IPO – DRHP Raises More Questions than in Answers
ESAF SFB ESAF Small Finance Bank Pre-IPO – Growing Fast but Remains Highly Dependant on a Related Party 
Flemingo Flemingo Travel Retail Pre-IPO – Its a Different Business in Every Country
Emami Cem Emami Cement Pre-IPO – Still in Ramp Up Phase but Shares Pledge Might Lead to an Early IPO 
NSENSE IPO Preview- Not Only Fast..its Risky and Expensive
NSENational Stock Exchange Pre-IPO Review – Bigger, Better, Stronger but a Little Too Fast for Some

LIC

Life Insurance Corporation of India Pre-IPO – Early Take on India’s Largest IPO 
Penna Cem Penna Cement – Aggressive Expansion Plans Even Though Past Performance Has Been Tepid 
PNB MetPNB Metlife Pre-IPO Quick Take – Doesn’t Stack up Well Versus Its Larger Peers
Samhi Hotels Samhi Hotels Pre-IPO – Assets and Borrowings Are Growing, but Earnings Haven’t Kept Pace 
Malaysia
QSRQSR Brands Pre-IPO – As Healthy as Fast Food
The U.S.
ForU ForU Worldwide Pre-IPO – Mostly Negatives 
Qiniu Qiniu Cloud (七牛云) Pre-IPO: PaaS Doesn’t Warrant a Premium 

Before it’s here, it’s on Smartkarma

Most Read: TAL Education, Ping An Insurance (H), SK Telecom, Kuaishou Technology and more

By | Daily Briefs, Most Read

In today’s briefing:

  • China After School Tutoring Online Education Stocks Crushed – Investors Schooled
  • Ping An A/H: Discount Widens and Diverges from Broader Market
  • Asia Shorts: Tencent, CMB, Ping An, Weimob, WuXi, Shimano, Cocokara, HMM, Kakao, Doosan, Yang Ming
  • SK Telecom’s Interim Dividends & The Removal of Foreign Ownership Restriction on SKT Investment?
  • Kuaishou Lock-Up Expiry – Getting Close to IPO Price, with US$18bn+ Lock-Up. CCASS Movement as Well.

China After School Tutoring Online Education Stocks Crushed – Investors Schooled

By Travis Lundy

Earlier today, it was reported by the 21st Century Business Herald that China was going to ban IPOs by educational companies and platforms which tutor on subjects in the public school curriculum and ban investments in such companies by those which are already listed. 

Bloomberg reported that China was considering asking companies that offer such tutoring – to help students pass the gaokao – the legendarily difficult college entrance exams – to turn into non-profit businesses. 

The initial story is that online education platforms would not be allowed to raise money in capital markets, sell securities, go public. The bigger picture is that they are effectively being pushed out of business. This particular news has sent education (especially school curriculum tutoring platforms) stocks dramatically lower in Hong Kong trading, and in the US pre-open market.

Drops of 30-50% are par for the course so far.

There is a possibility this kills the entire business for some platforms. 

This comes on the back of a crackdown starting earlier this spring on after-school tutoring platforms after Xi Jinping said in March at the Two Sessions that the practice was a “social problem” affecting kids social and mental health and he urged “resolute rectification.”

Right there, that should have warned everyone this story was not going to have a happy ending. 

This followed a scandal in January where four schools, including Yuanfudao, Zuoyebang, and the education unit all hired the same actress to pose as a teacher in ads for their platform, in at least one video laying the guilt on parents saying if parents didn’t sign up for the streaming courses, it could have consequences, “90% of mothers make mistakes” and “it could be parents themselves who ruin their kids [chances].” In one she was an English teacher with 35 years experience. In another she had been a math teacher all her career. It was not a good look.

The media followed Hi Jinping’s comments with polemics on predatory practices and fear-based advertising, which had gone rampant as the VC investees aimed at growth above all. This put an immediate halt to the preparations many of the mega-tech conglomerates invested in China – Alibaba Group (BABA US), Tencent (700 HK), Softbank Group (9984 JP), and others – had made to list their education-related projects such as Zuoyebang (Alibaba) which raised US$2.35bn in two rounds last year, Yuanfudao (Tencent) which raised US$3.5bn in three rounds, VIPKid (Tencent) which does English teaching, Huohua Siwei (Tencent) which specialises in STEM, and others which were either launching (like ByteDance’s newest effort Dali Education after buying Hua Luogeng math school and renaming it Qingbei Online School, and one-on-one tutoring platform GoGoKid), or preparing themselves to start on the road to IPO or at least looking at a 2022 listing. Zhangmen Education (ZME US) actually IPOed in late May at US$11.51/ADR, rising 50% on Day 1, falling back to US$9.54 yesterday and now down 26% in pre-market. 

Such companies had grown dramatically in 2020 as covid restrictions, or precautions, increased the desire for parents to keep their kids at home. Preqin says VC funding in the sector hit a record $10.5bn in 2020. The market is huge, and growing fast. Online tutoring grew 35-40% last year as covid struck according to iResearch in Shanghai, reaching RMB 257bn. Others have higher numbers. And according to Oliver Wyman and the National Institute of Educational Sciences, the overall market for after-school education was RMB 800bn in 2019, expected to rise to RMB 1.4trln in 2025.

The four major problems that regulators appear to have focussed on this spring after Xi Jinping’s comments were:

  • fast-increasing expense on families, which would restrict the incentive to have more kids and also create a significant separation between the chances for kids with well-to-do parents and kids without. The criticism in the 21 May 19th Meeting of Central Comprehensive Deepening Reform Commission, which released a flurry of Opinions* was that children faced a lower burden in school and a greater burden out of school.

*”Guiding Opinions on Improving the Evaluation Mechanism of Scientific and Technological Achievements”, “Opinions on Further Reducing the Burden of Students’ Homework and Off-campus Training in Compulsory Education”, and several others.

  • marketing free-for-all with false or damaging advertising and predatory plan pricing and structuring, including pre-charging for classes which would not be used. 
  • A lack of regulation/strict oversight of teacher/tutor licensing, ensuring proper resource allocation to teachers themselves, 
  • and a get-rich-quick mindset from what Xi Jinping thinks should be a solemn duty to educate the youth of the country. 

As Xinhua put it in reporting about that May 21 meeting…

会议强调,要全面规范管理校外培训机构,坚持从严治理,对存在不符合资质、管理混乱、借机敛财、虚假宣传、与学校勾连牟利等问题的机构,要严肃查处。要明确培训机构收费标准,加强预收费监管,严禁随意资本化运作,不能让良心的行业变成逐利的产业。要完善相关法律,依法管理校外培训机构。各级党委和政府要强化主体责任,做实做细落实方案,科学组织、务求实效,依法规范教学培训秩序,加强权益保护,确保改革稳妥实施。

The meeting emphasized that it is necessary to fully regulate the management of off-campus training institutions, adhere to strict governance, and severely investigate and deal with institutions that have problems such as non-qualification, chaotic management, taking advantage of money, false propaganda, and collusion with schools for profit. It is necessary to clarify the charging standards of training institutions, strengthen the supervision of pre-charging, and strictly prohibit arbitrary capitalization operations, and do not allow conscientious industries to become profit-seeking industries. It is necessary to improve relevant laws and manage off-campus training institutions in accordance with the law. Party committees and governments at all levels must strengthen their main responsibilities, implement the plan in detail, organize scientifically, seek practical results, standardize the order of teaching and training in accordance with the law, strengthen the protection of rights and interests, and ensure the steady implementation of reforms.

In April, the Beijing Administration for Market Regulation fined New Oriental Online RMB 500,000 for pricing violations, and false advertising. Koolearn (1797 HK), TAL Education (TAL US), were also hit.  Shifara Samsudeen, ACMA, CGMA wrote about this in GSX TechEdu: China Fines Online Tutoring Apps for Making Misleading Claims; Is GSX Next? in early May.

In late May, China decided kindergartens and private tutoring schools could no longer teach the elementary school curriculum, starting June 1, as part of a revision of the Minority Protection Law. Gaotu Techedu (GOTU US) immediately announced it was shutting down its Xiao Zao Qi Meng pre-school education business (3-8yrs). On June 1, the government fined another 15 operators a total of RMB 36.5mm for similar violations to New Oriental Online, including pre-IPO unicorns Zuoyebang and Yuanfudao, with both getting hit for RMB 2.5mm which is the maximum legal amount. New Oriental got hit again. TAL, Onesmart Education (ONE US), China BestStudy (3978 HK) and Bright Scholar Education (BEDU US) were also hit for the same reasons by SAMR. And then another 10 were hit by local regulators in Guangdong and Shanghai. It was a coordinated attack on Children’s Day.

In the first week of June, Xi Jinping made a much-touted visit to Qinghai in the southwest and it appears both he and the media talked quite a bit about lifting up the lower income areas and people, as per the 14th Five Year Plan, and also noted the problem of after school tutoring burdening students more and school burdening students less, calling it “putting the cart before the horse.”

The Ministry of Education set up a new department (the Off-Campus Education and Training Department) on 15 June to regulate the off-campus tutoring schools to “reduce students’ academic burden”, etc. It will oversee teachers and curricula. Smartkarma provider Zhen Zhou, Toh wrote about the prospects for companies going forward in late June in China Online Education – Diversified Revenue Stream Wins Here – Balance in All Things

Three weeks ago, the Beijing Municipal Education Commission and at least a half dozen other major cities across the country set up summer after-school programs for elementary school students, effectively taking the business which would normally be taken by private sector schools.

The writing has been on the wall since March. And the authorities have been writing over it in heavier and heavier marker for weeks and months.

The largest businesses out there have been under the cosh, racing against time and competitors with somewhat dodgy numbers and promises. They lose money, and now it looks like they won’t be able to raise more. 

A number of Smartkarma insight providers have published insights which have discussed the opportunities and the red flags in the sector. This includes short reports, pre-IPO reports, updates on legal and regulatory changes, and a huge report on the private education sector by Osbert Tang, CFA a few months ago, called China Private Education: This Is Where the Future Lies which has an enormous amount of detail about the sector.

Issues With the Business

The major issues for regulators appear to be…

  • criticisms of false advertising, where the benefits to such education are promised but not proven, where there are spurious claims using fake claims. 
  • criticisms of the structure of the offerings. A number of courses are offered at RMB 1 for the whole course, but then they come back to charge you for extras later. 
  • the “burden” placed on children
  • an air of get rich quick to the entire industry which is seen to be against the national interest.

For investors, many of the major issues have to do with how companies which promise growth are actually “growing.”

Gaotu, formerly called GSX Techedu, had claimed to be the leading provider of online classes from K-12, was IPOed in 2019 at a $3bn valuation, rose to 10x that, then fell. GSX had been the subject of short seller reports in the first half of 2020 accusing the company of inflating student enrolment numbers using bots, fabricating teachers, falsifying reviews, and falsifying revenues. Multiple reports (as per GMT Research’s Hall of Shame on GSX, Grizzly Research, Muddy Waters, JLWarren who wrote 30 May on Smartkarma in GSX: Minimal Market Share; ~80% Fake Enrollment and Operational Irregularities, GMT itself, and others (links at the bottom of that link) found different former teachers or others who talked about faked reviews, faked parents, faked students, bots/brushing, related party transactions to create expenses, or remove them (depending on the short seller report), boosted to remove the cash that should have been there from the fake revenue, possible fake capital raise, etc. The laundry list of accusations is long, sordid, and painfully similar to situations which have later been determined to be fraud. 

Against the pattern of companies calling out short seller research firms’ reports, GSX was often curiously quiet, and the stock rose anyway, tripling after Muddy Waters released their report from $40/share to $120/share before falling back.

The shares then rallied very sharply in January as part of a short squeeze on “meme stonks” and heavily-shorted names. Archegos apparently owned more than 10% through a variety of PB accounts. Archegos fell. GSX fell with it. And since then it has lost another two thirds of its value to get back to under US$10/share. 

Pre-market, it is apparently indicated at US$3.65/share. Down 62%. 

A Side Problem

Evelyn Zhang recently wrote about the change in attitude towards “white collar education” in A Twist of Fate – China’s Suppression of Secondary Education in Favor of Vocational Education. It is a good read. 

Her advice on 3 July was to short all Chinese online education stocks which had a K-12 offering, and go long all companies which provided vocational training.

After today, that will have been a beauty of a trade. 

Medium-term, the problem authorities will find is that parents don’t necessarily want their kids to not have access to the after-school cram services. They don’t have time to teach them themselves, and because the cutoff to continue later education is harsh and many parents don’t want their kids to go to vocational school to enter the blue collar workforce, lots of parents are actually objecting to the crackdown. They are happy to pay if it gives their kids a better chance. 

The high cost of education is one reason to not have a second (or third) child. The high cost of real estate is another. But education is status and a chance at wealth and intellectual happiness. It has been the case for hundreds of years in China. It is not clear that if the public sector takes on the education and after-school education “burden” from the private sector that it will please the wider public. It is not clear an increased number of qualified teachers will want to get paid public education system wages either. 

The Problem For Investors

Now the chickens are coming home to roost. 

Xi Jinping declared after-school education to be a “social problem” in front of the Two Sessions. Some people did not take him seriously at the time, but regulators have been taking his words seriously and have started cracking down. Legislators have made new legislation. And the Ministry of Education has a new department. 

Now it appears China wants foreign capital out of the business, and it wants those operators (already listed, or unicorns sponsored by China megatech) which have raised capital to not use it grow market share. 

It wants the entire business to support the national interest. Without profit. 

Larry Chen (founder and chairman of Gaotu), once a teacher in an impoverished little village, later become multi-billionaire, may not be able to keep his billions. And I expect this does not bother Xi Jinping.

A basket of names in HK, mainland China, and NYSE (using pre-market prices as of one minute before the open for today’s price) is shown below. It is a heavy hit.

By my count using pre-open prices and the ugly HK closes, that is $18bn in one shot on those 16 names.

More below the fold.


Ping An A/H: Discount Widens and Diverges from Broader Market

By Brian Freitas

The Ping An A-shares Ping An Insurance Group Co Of China (601318 CH) are trading at a 2.75% discount versus the H-shares Ping An Insurance (H) (2318 HK). This continues the cycle of premiums and discounts going back to 2015.

The last time the A-shares traded at a discount to the H-shares was in April this year. By mid May, the A-shares traded at a 5% premium to the H-shares before moving lower again.

With Ping An Insurance Group Co Of China (601318 CH) trading at a 2.75% discount to Ping An Insurance (H) (2318 HK) the risk/reward is favourable to setting up a premium expansion trade. The current discount lies at the 82nd percentile over the last 5 years and the discount has been widening as the premium of the overall market continues to increase.

Northbound holdings of Ping An Insurance Group Co Of China (601318 CH) have increased over the last couple of months, while the Southbound shareholding on Ping An Insurance (H) (2318 HK) has dropped sharply. This implies that mainland China investors have been selling the A-shares a lot more aggressively than the H-shares.

In this Insight, we look at the historical premium for Ping An and compare it to the premium on the AH index and other large caps, and look at some catalysts that could lead to an expansion of the premium.


Asia Shorts: Tencent, CMB, Ping An, Weimob, WuXi, Shimano, Cocokara, HMM, Kakao, Doosan, Yang Ming

By Brian Freitas

The Asia Short Interest weekly looks at moves in market wide short interest and highlights movements in stock specific short interest across Hong Kong, Japan, Korea and Taiwan using the last available data published by the relevant authorities.

Hong Kong saw shorts rise on Tencent (700 HK), China Merchants Bank H (3968 HK), Ping An Insurance (H) (2318 HK), Meituan (3690 HK) and Sunny Optical (2382 HK) while there was short covering on Weimob Inc. (2013 HK), Xiaomi Corp (1810 HK), JD.com Inc. (9618 HK), Nongfu Spring (9633 HK) and WuXi AppTec Co. Ltd. (2359 HK). Shorts increased in the Communication Services, Consumer Discretionary, Financials and Health Care sectors.

In Japan, stocks increased on Shimano Inc (7309 JP), Harmonic Drive Systems (6324 JP), Cocokara Fine (3098 JP), Nippon Steel Corporation (5401 JP) and Casio Computer (6952 JP) while there was short covering on Pharma Foods International (2929 JP), SUMCO Corp (3436 JP), BASE Inc (4477 JP), Showa Denko K.K. (4004 JP) and Kobe Steel Ltd (5406 JP). Shorts increased in the Consumer Discretionary, Industrials and Consumer Staples sectors while decreasing in the Health Care and Information Technology sectors.


SK Telecom’s Interim Dividends & The Removal of Foreign Ownership Restriction on SKT Investment?

By Douglas Kim

SK Telecom (017670 KS) announced today the interim dividends of 2,500 won per share for 2Q 2021. This would represent 177.9 billion won in amount. The basis date for receiving the interim dividends is 30 June 2021. The dividends are expected to be paid out on or prior to 11 August 2021. At the current price of 305,000 won, the quarterly interim dividend yield would represent 0.8% (annualized rate of 3.3%). 

Once SK Telecom (existing co) and SKT Investment become two separate companies on 29 November, SK Telecom will be treated as a telco while SKT Investment will be treated mainly as an investment company. What this means is that from the regulators’ point of view, there could be an increasing pressure to remove the entire foreign ownership restriction on SKT Investment. 

In conclusion, there have been some concerns about MSCI reducing its weight of SK Telecom in the coming months.

  • This is probably one of the reasons why SK Telecom’s share price has experienced some weakness in the past few weeks, although its share price is still up 28% YTD. 
  • Once SK Telecom (existing co) and SKT Investment become two separate companies on 29 November, SK Telecom will be treated as a telco while SKT Investment will be treated mainly as an investment company.
  • What this means is that from the regulators’ point of view, there could be an increasing pressure to remove the entire foreign ownership restriction on SKT Investment. 

Kuaishou Lock-Up Expiry – Getting Close to IPO Price, with US$18bn+ Lock-Up. CCASS Movement as Well.

By Sumeet Singh


Before it’s here, it’s on Smartkarma

Most Read: Evergrande Real Estate Group, Ping An Insurance (H), TAL Education, SK Telecom, Aventus Group and more

By | Daily Briefs, Most Read

In today’s briefing:

  • Smartkarma Flash Webinar | Evergrande: Quantifying Risks and Potential Domino Effect
  • Ping An A/H: Discount Widens and Diverges from Broader Market
  • China After School Tutoring Online Education Stocks Crushed – Investors Schooled
  • SKT MSCI Downweight Is a Golden Trading Opportunity: Entry/Closing Points Discussion
  • FTSE EPRA NAREIT Asia ADD Basket – More To Go

Smartkarma Flash Webinar | Evergrande: Quantifying Risks and Potential Domino Effect

By Smartkarma Research

Tune in for our Flash Webinar as we look at recent developments at Evergrande Real Estate Group (3333 HK). The highly indebted real estate company saw its share price jump from four-year lows on the resolution of a dispute with a Chinese bank, but trouble for China’s largest property developer seems far from over. Join us for a discussion with Insight Providers Travis Lundy and  Charles Macgregor on the current situation and where the company goes from here.

The flash webinar will be hosted on Friday, 23 July 2021, 4.00pm SGT/HKT.

Travis Lundy has 20+ years of experience in Asia doing alternative strategies (i.e. non-delta1 non long-only) in fixed income, equity derivatives, and activist/catalyst/event-driven and long-short equity strategies, with most of that time spent managing money.

Charles Macgregor is an industry veteran with over 35 years of experience. As Head of Asia, he is responsible for the Asian credit research product at Lucror, which he joined in 2013. Previously, he had worked for Deutsche Asset Management, where he was Head of Credit Research, Asia-Pacific and Co-Chair of their Global Credit Methodology Committee. He also worked at Moody’s, where he was a Senior Credit Officer and a member of their New Instruments Committee and Symbols & Definitions Committee.


Ping An A/H: Discount Widens and Diverges from Broader Market

By Brian Freitas

The Ping An A-shares Ping An Insurance Group Co Of China (601318 CH) are trading at a 2.75% discount versus the H-shares Ping An Insurance (H) (2318 HK). This continues the cycle of premiums and discounts going back to 2015.

The last time the A-shares traded at a discount to the H-shares was in April this year. By mid May, the A-shares traded at a 5% premium to the H-shares before moving lower again.

With Ping An Insurance Group Co Of China (601318 CH) trading at a 2.75% discount to Ping An Insurance (H) (2318 HK) the risk/reward is favourable to setting up a premium expansion trade. The current discount lies at the 82nd percentile over the last 5 years and the discount has been widening as the premium of the overall market continues to increase.

Northbound holdings of Ping An Insurance Group Co Of China (601318 CH) have increased over the last couple of months, while the Southbound shareholding on Ping An Insurance (H) (2318 HK) has dropped sharply. This implies that mainland China investors have been selling the A-shares a lot more aggressively than the H-shares.

In this Insight, we look at the historical premium for Ping An and compare it to the premium on the AH index and other large caps, and look at some catalysts that could lead to an expansion of the premium.


China After School Tutoring Online Education Stocks Crushed – Investors Schooled

By Travis Lundy

Earlier today, it was reported by the 21st Century Business Herald that China was going to ban IPOs by educational companies and platforms which tutor on subjects in the public school curriculum and ban investments in such companies by those which are already listed. 

Bloomberg reported that China was considering asking companies that offer such tutoring – to help students pass the gaokao – the legendarily difficult college entrance exams – to turn into non-profit businesses. 

The initial story is that online education platforms would not be allowed to raise money in capital markets, sell securities, go public. The bigger picture is that they are effectively being pushed out of business. This particular news has sent education (especially school curriculum tutoring platforms) stocks dramatically lower in Hong Kong trading, and in the US pre-open market.

Drops of 30-50% are par for the course so far.

There is a possibility this kills the entire business for some platforms. 

This comes on the back of a crackdown starting earlier this spring on after-school tutoring platforms after Xi Jinping said in March at the Two Sessions that the practice was a “social problem” affecting kids social and mental health and he urged “resolute rectification.”

Right there, that should have warned everyone this story was not going to have a happy ending. 

This followed a scandal in January where four schools, including Yuanfudao, Zuoyebang, and the education unit all hired the same actress to pose as a teacher in ads for their platform, in at least one video laying the guilt on parents saying if parents didn’t sign up for the streaming courses, it could have consequences, “90% of mothers make mistakes” and “it could be parents themselves who ruin their kids [chances].” In one she was an English teacher with 35 years experience. In another she had been a math teacher all her career. It was not a good look.

The media followed Hi Jinping’s comments with polemics on predatory practices and fear-based advertising, which had gone rampant as the VC investees aimed at growth above all. This put an immediate halt to the preparations many of the mega-tech conglomerates invested in China – Alibaba Group (BABA US), Tencent (700 HK), Softbank Group (9984 JP), and others – had made to list their education-related projects such as Zuoyebang (Alibaba) which raised US$2.35bn in two rounds last year, Yuanfudao (Tencent) which raised US$3.5bn in three rounds, VIPKid (Tencent) which does English teaching, Huohua Siwei (Tencent) which specialises in STEM, and others which were either launching (like ByteDance’s newest effort Dali Education after buying Hua Luogeng math school and renaming it Qingbei Online School, and one-on-one tutoring platform GoGoKid), or preparing themselves to start on the road to IPO or at least looking at a 2022 listing. Zhangmen Education (ZME US) actually IPOed in late May at US$11.51/ADR, rising 50% on Day 1, falling back to US$9.54 yesterday and now down 26% in pre-market. 

Such companies had grown dramatically in 2020 as covid restrictions, or precautions, increased the desire for parents to keep their kids at home. Preqin says VC funding in the sector hit a record $10.5bn in 2020. The market is huge, and growing fast. Online tutoring grew 35-40% last year as covid struck according to iResearch in Shanghai, reaching RMB 257bn. Others have higher numbers. And according to Oliver Wyman and the National Institute of Educational Sciences, the overall market for after-school education was RMB 800bn in 2019, expected to rise to RMB 1.4trln in 2025.

The four major problems that regulators appear to have focussed on this spring after Xi Jinping’s comments were:

  • fast-increasing expense on families, which would restrict the incentive to have more kids and also create a significant separation between the chances for kids with well-to-do parents and kids without. The criticism in the 21 May 19th Meeting of Central Comprehensive Deepening Reform Commission, which released a flurry of Opinions* was that children faced a lower burden in school and a greater burden out of school.

*”Guiding Opinions on Improving the Evaluation Mechanism of Scientific and Technological Achievements”, “Opinions on Further Reducing the Burden of Students’ Homework and Off-campus Training in Compulsory Education”, and several others.

  • marketing free-for-all with false or damaging advertising and predatory plan pricing and structuring, including pre-charging for classes which would not be used. 
  • A lack of regulation/strict oversight of teacher/tutor licensing, ensuring proper resource allocation to teachers themselves, 
  • and a get-rich-quick mindset from what Xi Jinping thinks should be a solemn duty to educate the youth of the country. 

As Xinhua put it in reporting about that May 21 meeting…

会议强调,要全面规范管理校外培训机构,坚持从严治理,对存在不符合资质、管理混乱、借机敛财、虚假宣传、与学校勾连牟利等问题的机构,要严肃查处。要明确培训机构收费标准,加强预收费监管,严禁随意资本化运作,不能让良心的行业变成逐利的产业。要完善相关法律,依法管理校外培训机构。各级党委和政府要强化主体责任,做实做细落实方案,科学组织、务求实效,依法规范教学培训秩序,加强权益保护,确保改革稳妥实施。

The meeting emphasized that it is necessary to fully regulate the management of off-campus training institutions, adhere to strict governance, and severely investigate and deal with institutions that have problems such as non-qualification, chaotic management, taking advantage of money, false propaganda, and collusion with schools for profit. It is necessary to clarify the charging standards of training institutions, strengthen the supervision of pre-charging, and strictly prohibit arbitrary capitalization operations, and do not allow conscientious industries to become profit-seeking industries. It is necessary to improve relevant laws and manage off-campus training institutions in accordance with the law. Party committees and governments at all levels must strengthen their main responsibilities, implement the plan in detail, organize scientifically, seek practical results, standardize the order of teaching and training in accordance with the law, strengthen the protection of rights and interests, and ensure the steady implementation of reforms.

In April, the Beijing Administration for Market Regulation fined New Oriental Online RMB 500,000 for pricing violations, and false advertising. Koolearn (1797 HK), TAL Education (TAL US), were also hit.  Shifara Samsudeen, ACMA, CGMA wrote about this in GSX TechEdu: China Fines Online Tutoring Apps for Making Misleading Claims; Is GSX Next? in early May.

In late May, China decided kindergartens and private tutoring schools could no longer teach the elementary school curriculum, starting June 1, as part of a revision of the Minority Protection Law. Gaotu Techedu (GOTU US) immediately announced it was shutting down its Xiao Zao Qi Meng pre-school education business (3-8yrs). On June 1, the government fined another 15 operators a total of RMB 36.5mm for similar violations to New Oriental Online, including pre-IPO unicorns Zuoyebang and Yuanfudao, with both getting hit for RMB 2.5mm which is the maximum legal amount. New Oriental got hit again. TAL, Onesmart Education (ONE US), China BestStudy (3978 HK) and Bright Scholar Education (BEDU US) were also hit for the same reasons by SAMR. And then another 10 were hit by local regulators in Guangdong and Shanghai. It was a coordinated attack on Children’s Day.

In the first week of June, Xi Jinping made a much-touted visit to Qinghai in the southwest and it appears both he and the media talked quite a bit about lifting up the lower income areas and people, as per the 14th Five Year Plan, and also noted the problem of after school tutoring burdening students more and school burdening students less, calling it “putting the cart before the horse.”

The Ministry of Education set up a new department (the Off-Campus Education and Training Department) on 15 June to regulate the off-campus tutoring schools to “reduce students’ academic burden”, etc. It will oversee teachers and curricula. Smartkarma provider Zhen Zhou, Toh wrote about the prospects for companies going forward in late June in China Online Education – Diversified Revenue Stream Wins Here – Balance in All Things

Three weeks ago, the Beijing Municipal Education Commission and at least a half dozen other major cities across the country set up summer after-school programs for elementary school students, effectively taking the business which would normally be taken by private sector schools.

The writing has been on the wall since March. And the authorities have been writing over it in heavier and heavier marker for weeks and months.

The largest businesses out there have been under the cosh, racing against time and competitors with somewhat dodgy numbers and promises. They lose money, and now it looks like they won’t be able to raise more. 

A number of Smartkarma insight providers have published insights which have discussed the opportunities and the red flags in the sector. This includes short reports, pre-IPO reports, updates on legal and regulatory changes, and a huge report on the private education sector by Osbert Tang, CFA a few months ago, called China Private Education: This Is Where the Future Lies which has an enormous amount of detail about the sector.

Issues With the Business

The major issues for regulators appear to be…

  • criticisms of false advertising, where the benefits to such education are promised but not proven, where there are spurious claims using fake claims. 
  • criticisms of the structure of the offerings. A number of courses are offered at RMB 1 for the whole course, but then they come back to charge you for extras later. 
  • the “burden” placed on children
  • an air of get rich quick to the entire industry which is seen to be against the national interest.

For investors, many of the major issues have to do with how companies which promise growth are actually “growing.”

Gaotu, formerly called GSX Techedu, had claimed to be the leading provider of online classes from K-12, was IPOed in 2019 at a $3bn valuation, rose to 10x that, then fell. GSX had been the subject of short seller reports in the first half of 2020 accusing the company of inflating student enrolment numbers using bots, fabricating teachers, falsifying reviews, and falsifying revenues. Multiple reports (as per GMT Research’s Hall of Shame on GSX, Grizzly Research, Muddy Waters, JLWarren who wrote 30 May on Smartkarma in GSX: Minimal Market Share; ~80% Fake Enrollment and Operational Irregularities, GMT itself, and others (links at the bottom of that link) found different former teachers or others who talked about faked reviews, faked parents, faked students, bots/brushing, related party transactions to create expenses, or remove them (depending on the short seller report), boosted to remove the cash that should have been there from the fake revenue, possible fake capital raise, etc. The laundry list of accusations is long, sordid, and painfully similar to situations which have later been determined to be fraud. 

Against the pattern of companies calling out short seller research firms’ reports, GSX was often curiously quiet, and the stock rose anyway, tripling after Muddy Waters released their report from $40/share to $120/share before falling back.

The shares then rallied very sharply in January as part of a short squeeze on “meme stonks” and heavily-shorted names. Archegos apparently owned more than 10% through a variety of PB accounts. Archegos fell. GSX fell with it. And since then it has lost another two thirds of its value to get back to under US$10/share. 

Pre-market, it is apparently indicated at US$3.65/share. Down 62%. 

A Side Problem

Evelyn Zhang recently wrote about the change in attitude towards “white collar education” in A Twist of Fate – China’s Suppression of Secondary Education in Favor of Vocational Education. It is a good read. 

Her advice on 3 July was to short all Chinese online education stocks which had a K-12 offering, and go long all companies which provided vocational training.

After today, that will have been a beauty of a trade. 

Medium-term, the problem authorities will find is that parents don’t necessarily want their kids to not have access to the after-school cram services. They don’t have time to teach them themselves, and because the cutoff to continue later education is harsh and many parents don’t want their kids to go to vocational school to enter the blue collar workforce, lots of parents are actually objecting to the crackdown. They are happy to pay if it gives their kids a better chance. 

The high cost of education is one reason to not have a second (or third) child. The high cost of real estate is another. But education is status and a chance at wealth and intellectual happiness. It has been the case for hundreds of years in China. It is not clear that if the public sector takes on the education and after-school education “burden” from the private sector that it will please the wider public. It is not clear an increased number of qualified teachers will want to get paid public education system wages either. 

The Problem For Investors

Now the chickens are coming home to roost. 

Xi Jinping declared after-school education to be a “social problem” in front of the Two Sessions. Some people did not take him seriously at the time, but regulators have been taking his words seriously and have started cracking down. Legislators have made new legislation. And the Ministry of Education has a new department. 

Now it appears China wants foreign capital out of the business, and it wants those operators (already listed, or unicorns sponsored by China megatech) which have raised capital to not use it grow market share. 

It wants the entire business to support the national interest. Without profit. 

Larry Chen (founder and chairman of Gaotu), once a teacher in an impoverished little village, later become multi-billionaire, may not be able to keep his billions. And I expect this does not bother Xi Jinping.

A basket of names in HK, mainland China, and NYSE (using pre-market prices as of one minute before the open for today’s price) is shown below. It is a heavy hit.

By my count using pre-open prices and the ugly HK closes, that is $18bn in one shot on those 16 names.

More below the fold.


SKT MSCI Downweight Is a Golden Trading Opportunity: Entry/Closing Points Discussion

By Sanghyun Park

Currently, the hottest trading issue in the Korean local market is SK Telecom’s MSCI downweight play. At the current foreign room (5.29%), a 75% weight-down is pretty much guaranteed.

Passive impact

We are currently receiving a full 1.0 FIF (foreign inclusion factor) adjustment coefficient. So, if downgraded to 0.25, it will lead to a 75% outflow of funds.

Post review adjustment factorForeign room (1-FOL burnout)
Current adjustment factor≥ 25%15~25%7.5~15%3.75~7.5%< 3.75%
1.001.001.000.500.250.00
0.501.000.500.500.250.00
0.251.000.500.250.250.00
Source: MSCI

Here is an estimation of a passive impact on SKT. Assuming that the size of passive funds following MSCI Standard Korea is ₩80T, approximately ₩830B of passive funds are estimated to have flowed into SKT. Since this is a 75% decrease, ₩622B is expected to be sold. At the last close, this is slightly over 2 million shares, and it will have a fairly large impact, about 10 times ADTV.

Passive impact
30-day average daily trading volume204,385
– Value₩65.5B
Total estimated passive funds mirroring MSCI Korea₩80,000.0B
Estimated passive outflow₩622.2B
Estimated passive outflow/ADTV9.49x
Source: KRX & MSCI

FTSE EPRA NAREIT Asia ADD Basket – More To Go

By Travis Lundy

FTSE EPRA Nareit launched a change in Ground Rules on 24 June. As discussed in FTSE EPRA NAREIT Ground Rule Changes – Impact on J-REITs/Developed Asia Lessors, the big change was a lowering of the hurdle rate for entry within the Asia Pacific sub-index to the global level for DM markets, and that meant a number of REITs and property companies in Asia which had been just too small to get in will now more likely get into the index in September. 

The announcement is due 1 September. The inclusion date is 17 September.

This caught investors by surprise, and baskets were hurriedly formed. The Quiddity basket is a total of 38 we-think-likely candidates (there are some slight oddities in the calcs).

We are now exactly four weeks in. There are five weeks left. The 38-name Basket has out-performed the FTSE EPRA Nareit AsiaPac index by 6.5% since the close of 24 June and 2.7% since I wrote about it 1 July. 

An update on the progression, the dispersion, and the excess volume traded to-date is below.


Before it’s here, it’s on Smartkarma